Current Events

The Truth about the Commodities Drop of 2017

2016 has been off to a rough start – in fact it is the worst start in history and for many, 2016 is stirring up memories of 2008. I believe that this fear is unfounded and stemming from misinterpreting the oil and commodities drop. They are symptoms, I believe, of the credit bubble bursting and the overproduction which stemmed from futures contracts in the 1990s and 2000s. Despite this, I still think that we are in a super cycle, and as with previous super cycles, there will be some winners and some losers. We wouldn’t be in a super cycle if everything was going smoothly.

Where oil and other commodities are concerned, there is lots of supply and no demand. During the 1990s and 2000s, people believed that the price of oil would only continue to rise and so, many futures contracts were taken out. Airports and the like took them with the intention to collect on their contracts, but many – as much as 50% – were speculative, with no intention of ever taking possession. In addition, it became common for commodities to be treated as an asset class, and more investors joined the speculative boom that way. Futures contracts make sense if the prices continue to climb, but if the price drops, not only do you lose your investment, but you owe additional money as well. Often the money used to pay back the speculative contracts was pulled from other speculative contracts. In this way, I believe that the drop in oil prices was also the catalyst for other commodity prices to fall as well.

The speculation which caused prices to increase also saw trillions invested into factories, plants, and drilling to keep up with the nonexistent demand. $2 trillion was invested into factories in India and China alone, and $6 trillion was invested into oil drilling in Brazilian coast, Australia outback, and South Dakota. The additional investment helped create the oversupply and among others, China’s steel production quadrupled between 2000 and 2015. That is an excess of 600,000,000 tons, and across the globe in Scotland, steel factories are closing – and we are likely to see them closing here as well. A lot of money went into factories, as during the housing market when a great deal of building resulted in many empty homes. We saw banks and businesses close in 2008, and likewise in 2015, 25 energy companies defaulted on their loans and I suspect there are more to come. Despite the drop in oil, though, the S&P book value has continued to grow. I think this is because oil companies

saw the drop as very temporary and continue to carry reserves at full value ($100 to $110), and this spring auditors will force them to market value. I believe this will result in significant defaults and bankruptcies which will affect the market and earnings.

There is good news for the American companies and consumers looking to purchase steel, oil, and other commodities. The price drop will make raw materials cheaper to purchase. I also believe that outside of energy and commodities there will be real growth coming in the market. But as I have said before, to quote Richard Bernstein, it will be a tough year for investors, but perhaps not for investing.

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