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Commodities Are Half Way There: Source

A July 19th report from multi-asset research firm Source argues that despite recent losses in the commodities sector, there is still more room on the downside as structural as well as cyclical factors are in play in terms of the supply/demand curve in both the precious metals and energy markets.

Source Head of Research Paul Jackson and research associate András Vig argue that: “A revitalized dollar has contributed to recent weakness in commodities. However, we think more than the dollar is at play and expect raw material prices to fall a lot further.”

Understanding supercycles in commodities

The key question right now, of course, is whether the sell-off in commodities is finally ending. Of note, Brent crude peaked at $146 in March 2008 and is currently trading below $57; gold hit $1,900 in September 2011 and trades today at $1,134; industrial metal copper hit its peak of $10,160 in February 2011 and is now $5,480, and iron ore, which topped out at $192 in February 2011, is now just above $51.

Jackson and Vig point out that it is a natural human tendency to seek bargains after such big price drops, but they argue that these declines in commodity prices should be considered in the context of the so-called “supercycle”. Figure 1 illustrates how, for nearly 150 years, the price of U.S. oil has been between $20 and $60 (in today’s prices). But whenever the price of oil spikes above that range, it inevitably falls back, in many cases all the way back to $20.

They note: “If history is a guide, oil may still have some way to fall, helped by increased production from OPEC, rising inventories in the US and the return of Iran to international markets (Bloomberg estimates that Iran can eventually add another 1mb/d to current production of 2.85mb/d, on top of which it is reckoned Iran has floating storage of around 40mb – see here).”

Given that gold does not have the same industrial uses as oil and base metals, this means and the primary reasons for investing in the precious metal are fears of inflation and/or financial meltdown.

There, it’s not too surprising that gold prices spiked to almost $2000 an ounce when the financial and Eurozone crises struck in 2007 and 2008.  As fears subsided, however, the price of gold dropped, and many argue it is now at an “attractive level”


Figure 2 makes it clear that even in real terms, the current price of gold far higher than the historical averages of most of the last 200 years. Jackson and Vig point out this means that there is still a good bit of fear in the price of gold.

They argue: “Looking at shorter term charts, the moment of truth is nigh — gold is either set for a rebound or a move to a lower range (if it moves lower, it looks as though $1100 could be the next consolidation area, then the $800-$1000 range).”