Is the commodity boom about to go bust?

Essentially for nearly the past two years commodity futures have rallied in part due to strong global demand, and in part due to tight supplies of many commodities. The rally was also linked to fund money buying many commodities as a means to hedge against inflation.

Over the past two months many commodity futures have taken a plunge lower due to second quarter profit taking by some of those fund groups as the Federal Reserve scheduled a hefty increase in interest rates as a means to curb inflation.

While this interest rate increase was aimed at efforts to cool inflation, now the fear is that the United States could face a recession. Also overall global economic growth may be curtailing, in addition to continued concerns about Chinese economic growth post-COVID. Looking forward, the Fed was expected to increase interest rates again in late July in efforts to continue to slow the runaway inflation train.

The net climactic result had fund traders and other traders selling their commodity positions en masse, as though the global demand for commodities had stopped on a dime. We clearly know that is not the case, as demand for commodities is a continuous factor.

But was the recent sell in June and early July sell off enough to tame the inflationary talk, especially with most grain commodity prices now back at price levels from summer of 2021 (before the inflation rally occurred, before the South American bean crop struggled and before Russia invaded Ukraine)?

With higher interest rates and higher inflation, is demand starting to falter? Consider that China has been on new COVID lockdowns, which has kept an estimated 17% of their population at home, not consuming as many commodities as potentially they normally would have. This is definitely keeping some demand at bay as well.

Going forward, here are three market factors I’m watching in the approaching weeks that may shed light on the answer.

Interest rates

As you already know, during the June Fed meeting interest rates were increased. It is largely expected that the Fed may continue to increase interest rates very rapidly in the coming months. Including the latest rate hike, the Fed has already lifted rates by 1.5 percentage points this year, putting its benchmark interest rate at a range of 1.5% to 1.75%.

The minutes from the Fed’s June 14 to 15 meeting show that officials agreed that the central bank needed to raise its benchmark interest rate to "restrictive" levels that would slow the economy’s growth and “recognized that an even more restrictive stance could be appropriate” if inflation persisted.

The recent pullback in energy prices could mean lower gas prices in a few weeks and could signal that inflation is peaking, along with a cooling housing market, which may lessen the Feds need to increase interest rates so dramatically. If the Fed holds off on further interest rate hikes, that may help keep commodity prices supported for now.

Recession evidence

Many economists say a U.S. recession is very likely this year. Most define a recession as two straight quarters of downward growth. The economy contracted at a 1.6% annual rate in the first quarter, and recently, the Atlanta Fed’s “GDP Now” tracker predicted that GDP growth will likely also decrease in a second straight quarter, with the official information being released soon.

A well-known recession indicator flashed in the bond market in early July, as the U.S. yield curve inverted. This indicator occurs when shorter-dated yields such as for the two-year bond are higher than for longer-dated debt such as the 10-year.

If evidence of a recession is seen, that alone might trigger another sell off in commodity prices as trade assumes that commodity demand will fall as businesses may not need to purchase as many raw commodities on the assumption that the consumer will not be interested or able to purchase the end product.

Goldman Sachs Commodity Index

I’ve written before about the Goldman Sachs Commodity Index, and if you’ve heard me give speeches across the Midwest, I often incorporate a chart image of this index into my presentations. This index is important because it measures the value of 24 different commodities, all into one index number. The metric is a mix of precious metals, energies, grains, livestock, and softs (i.e., cotton, sugar, coffee, and cocoa).

During the month of June, this index posted a bearish key reversal on monthly charts. To me that says for now, commodity markets have likely topped, and need to take a further breather. During the first week of July, commodity prices have indeed sold off, with prices now testing long term uptrend lines in many of those individual commodity markets, in addition to the long-term uptrend on the index itself, which had bottomed in April 2020, right after the COVID-19 sell off.

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In the past, the index has flashed this potential topping signal six times over the past 16 years.

The first time was back in August 2006, and the price setback lasted for five months.

The next was the infamous 2008 commodity sell off when the market peaked in July 2008 and crashed lower for seven months.

In May 2010, the index showed a short-term peak, which actually did not lead to a crash, but rather a four-month sideways consolidation phase.

The next peak occurred during May 2011, with the index then falling lower for five months.

In October 2018, was the next bearish technical signal, with prices then falling for three months.

In January 2020 was when the reality of COVID-19 was beginning to awaken the globe, with the index falling for four months, and also when we learned that commodity prices could indeed trade negative, with crude oil futures walloping lower into a negative price abyss.

The next question is how long will this sell off last? Three months? Or closer to five months or even seven months like 2008?

Unfortunately, this may be one of those times when commodity prices bow to the pressure of outside market influence, rather than the true supply and demand fundamentals of the commodity itself. For grain farmers, this can be nerve wracking, as they witness the crops in their field wither from drought concerns, as we still are unsure what official planted acre numbers are in this country for crops growing in the fields, or if Ukraine will be able to harvest the reduced crop growing in their fields right now.

I can tell you this, I take heed in that Goldman Sachs Commodity Index chart posting potential topping signals, and I also fear the possibility of a U.S. recession to become a reality. While the U.S. may not have a record crop growing in the fields, it might not matter if global demand is tempered.

Be advised, my “bullish” horns have been retracted, with my “bearish” claws coming out.

Editor’s note: Naomi Blohm is a marketing advisor with Total Farm Marketing by Stewart-Marketing and she is a regular contributor to the Iowa PBS series “Market to Market.” She can be reached at [email protected].