If there is a market that draws special attention in Latin America, it is the market for raw materials. The economies of the region are widely exposed to price fluctuations in markets such as corn, soy beans and copper, not to mention the region’s number-one commodity: petroleum.
At the beginning of this year, the governments of Latin America were very happy to watch how prices in these markets were moving. But their cheers turned into frowns during the summer: The Bloomberg Commodity Index, which tracks prices for 22 raw materials, closed the third quarter of 2016 with a sharp decline, after registering significant increases over the first two quarters of this year. Coincidence or not, ever since this kind of data began to be recorded in 1991, such a pattern has happened in only four years — and when it has happened, in three of those four cases, there was a sharp drop in prices in the subsequent fourth quarter of that year.
These sorts of statistics are not the only factor that is making people pessimistic. So is the way investors are reacting to the situation. From corn to petroleum, the existing oversupply in commodities has been making investors nervous about the future. From mid-August to mid-September, investors pulled $791 million out of exchange-traded funds tracking commodities, a reversal from earlier this year that still left inflows up by $34.1 billion this year. Along the same lines, high-risk hedge funds reduced their exposure to raw materials. Said Rob Haworth, Seattle-based investment strategist for U.S. Bank Wealth Management, which manages an investment portfolio of $133 billion, “There’s just not enough to keep speculators interested. There’s not been enough momentum or follow-through in any commodity price.”
Mauro Guillen, Wharton management professor and head of the School’s Lauder Institute, notes, “The issue is that many of these countries have become addicted to commodities. During the 1950s, 1960s and 1970s, they tried to separate themselves from the commodity cycle by investing in manufacturing. Many of those investments were not very good, so they went through a big crisis during the 1980s. And the funny thing is that since then, especially between 2000 and 2008, these economies became addicted again to commodities. When China’s economy slowed down, and prices for commodities came down, many of these countries – Brazil, Peru, Argentina, Bolivia, Venezuela – got into a lot of trouble. The only exception is Mexico. It does have natural resources, but over the last 30 years, thanks to NAFTA, it has become a manufacturing economy, essentially linked to the U.S. economy. Other than Mexico, all of the others continue to be dependent on the commodity cycle. As for Colombia, hopefully they will find a solution to the peace agreement, and then Colombia will also be able to perform very well.”
A Cyclical Change?
These developments have called into question those voices that had claimed that a cyclical change of raw material prices had begun, following the rising prices experienced during the first two quarters of 2016. “It is hard to know, but I doubt that we are confronting a change in the cycle of primary prices,” says Hernando Zuleta, a professor of economics at the University of the Andes in Colombia. “I believe that in order to have a sustained recovery, it would be necessary for the major economies to grow more rapidly. Moreover, supply factors are involved in these price increases. At the moment, I don’t see any signs that either of those two things is happening.”
“You cannot transform these economies or make them less dependent on the commodity cycle unless you invest in education and infrastructure.” –Mauro Guillen
Zuleta adds, “I believe that in around two or three years, we will see the impact of low prices on the supply of raw materials. Then there will be a lasting increase in their prices.” Since the end of June, the Bloomberg Commodity Index has declined by 6.7%. These losses include a 41% plunge in some of the most important components, including 23% for soy futures, and 11% in petroleum futures. In the last month alone, investors withdrew $991 million from energy sector ETFs and $39 million from raw materials ETFs. Nevertheless, prices of some raw materials, including gold, continue to move strongly upward.
Key Factors in the Market
During the first half of 2016, investors placed their money into raw materials, based on speculation that the United States Federal Reserve would slowly raise interest rates, which would consequently weaken the dollar and make prices of raw materials cheaper for those who hold other currencies. At the moment, after digesting recent comments made by some members of U.S. Federal Reserve, analysts say there is a 50% probability that the Fed will raise rates by the end of the year.
However, the price declines haven’t resulted merely from expectations about interest rates. The oversupply that exists in the markets for some products is exerting strong downward pressure on their prices — for example, with corn and copper. The U.S. Department of Agriculture expects that the country will achieve a record high grain crop this year, while Antofagasta, a Chilean producer of copper, forecasts that the current excess of supply in the copper market will last two or three more years.
According to Lourdes Casanova, academic director at the Institute of Emerging Markets of the S.C. Johnson School of Management at Cornell University, “It is not easy to forecast the price of raw materials, and almost all of us make mistakes.” However, Casanova does not expect production levels to reach new heights over the short or medium term. She also doesn’t expect a short-term increase in the price of petroleum.
Petroleum is the product that is traded the most in the world, “and the rest of the products follow its pattern,” Casanova notes. From a macroeconomic point of view, Casanova also sees no major reason for commodities prices to rise for a sustained period. “The growth of the world economy — except in China and India — are continuing at a lackluster pace. And so I don’t believe that we are facing a cycle such as the one we had in the previous decade.”
Adapting to Circumstances
Now that short- and medium-term expectations for a new cycle of price increases have been shattered, Latin America will have to learn how to cope without depending on this source of strong economic growth, economists agree. That was one of the conclusions noted by the International Monetary Fund (IMF) and the World Bank at the annual conference of the Development Bank of Latin America (CAF) in Washington in September. Top economists at the IMF and the World Bank noted that Latin America is in a “weak” fiscal position and has a “lower margin for maneuvering” to deal with the current context of the economic recession. In July, the IMF forecast that at the end of 2016, Latin America will remain in a recession — for the second consecutive year — with its Gross Domestic Product (GDP) declining by 0.4%.
“Most of the Brazilian GDP is not related to agriculture or commodities. [Rather,] Brazil is a services