After this post about commodities, I thought I should look at the pros and cons of declining commodity prices.
-Cheaper commodity prices helps consumer and allows for cheaper production.
Low prices may provide for discouragement to develop in the sector and provide good opportunities.
-The valuations are being neglected and the volatility in P/B ratios are consolidating. The technical setup of the price/book suggests a big move most likely higher in the price to book developing. (Unfortunately, high price/book could just mean declining book value rather than increasing price.)
-The economy is perhaps less dependent upon commodity prices than it used to be. We’re not in the agrarian or industrial ages when the economy ran on food output and oil prices. We’re somewhere between the services and technology era (or information age if you prefer).
side note: I suspect the “cybernetic age” is ahead where the old rules correlating employment rate and economic growth begin to diverge as robots/machines can do more and more to take over a lot of the old tasks. Meanwhile the economy becomes less about how the major institutions are doing and more about the individual company using crowd sourcing to fund projects and compete with the big companies as the creme rises to the crop.
-Any future increase may help commodity stocks and may lift the market.
-1998 had notoriously low oil and gold prices which matches the analog of having a roaring market ahead.
-The speed of decline may signal deflation is hitting the overall economy even if it hasn’t effected stocks yet. Even if it is similar to 1998, the other side could be devastating.
-If I potential rise in commodity IS coming then all the pros about low prices helping consumer and businesses may in the future actually hurt everything that it should help. As a forward pricing mechanism, then markets may price in a rise in commodity prices soon.[[[However, since more attention is being paid to the negatives of declining oil/commodities, then rising would be seen as good. Either way, you should look at the uncommon or contrarian view in this manner.]]
-A complicated implication that I won’t get into too much detail about is that the impact of low oil on countries like Russia may have influenced events that create the conditions to lead to WWIII.
I tend to actually place greater weight on the bearish side, but the good news is, none of the reasons you should be bearish are necessarily immediate. In other words, we could continue to match the 1998 analog of having a roaring market ahead before the impact is felt.
We could easily have 6 months to 3 years of upside in stocks before the deflation hitting the oil market effects the stock market. The 2005-2007 period saw deflation of housing market, inflation of energy markets. It wasn’t until long after the losses from the banks and subprime, that it really began to spill over into the global economy…. Even if there’s a similar effect, that doesn’t necessarily mean the speed of the 2015 decline has any immediate impact in stock prices even if commodity prices don’t bottom soon. And if they do, we still could very easily see the markets continue higher until they reach their extreme while commodities and companies in that space quietly begin to pick up steam as an investment.
It’s also worth looking at 1998-2000 as energy prices and commodity prices swung to their extreme lows as the market rose, before rising in sync with the stock market, and continuing upwards without ever taking out that low even during the 2000-2002/2003 decline in the economy.
Nevertheless, 1998-2000 was a great time period to invest in commodities. That doesn’t mean that trading stocks short term was a bad idea, or even holding if you could get out before the top. However, for asset allocators and long term buy and hold investors, it may be a decent time to look at commodities and continue to watch that space for opportunities.Twitter