The impact of falling commodity prices

Anyone who's been keeping an eye on the global commodities markets will not have failed to notice the sharp slump in prices that's been going on for the last month. Led by a decline in the cost of energy, everything from gold to sugar has dropped in value, and the impacts are being felt globally

But are these impacts positive or negative? And as an investor, should you steer clear of commodities for the time being or is it a good area to be involved in right now? Here we take a closer look at both questions.

What is causing the slump?

There are several factors contributing to the slump in commodity prices, and falling demand is arguably the most important one. Global economic growth has softened and as a result demand for industrial metals, oil and agricultural resources has weakened considerably.

A slowdown in China is playing a massive role here. The country is a major consumer of commodities, and in previous years its seemingly insatiable demand – created by an economic boom – has helped to maintain price growth.

Now, as exports plummet, the stock market continues to fall and the country moves to devalue its currency, that demand is waning and this is being reflected in prices.

Add to this a glut in supply, and it becomes even more apparent why commodity prices are falling. During China's economic boom energy and metal companies around the world ramped up production to levels that are now unsustainable.

And then there is the strong US dollar, which makes commodities – most of which are priced in dollars – more expensive to buy in other currencies and further compounds the demand problem.

The impacts

Lower commodity prices clearly have a positive impact for consumers. Who doesn't appreciate cheaper fuel, energy and food? And we're not just talking about motorists and homeowners, but also companies that rely heavily on oil, gas and industrial metals, as well as importing nations.

On the other side, major commodity exporting countries such as Russia and Brazil will be among the biggest losers, and of course mining companies and oil producers have already been cutting jobs and reducing their capital expenditure – proof that they are feeling the effects.

As for the impact on the equity markets, we have already seen share prices dragged lower as a result of this commodity slump. The FTSE 100, for example, has suffered large losses recently because it is more exposed to commodities than markets elsewhere around the world.

But the effects of falling commodity prices can be felt much further than this. For example, there are concerns that lower oil prices in particular could put downward pressure on inflation in developed economies and further delay the hiking of interest rates.

However, deflation isn't necessarily a bad thing, according to David Kelly, chief global strategist at JP Morgan Funds. "There's good deflation and bad deflation," he told CNBC. "Lower oil prices are a clear positive for the US economy, for the Chinese economy and the European economy. This stimulates the economy's growth; it doesn't depress it."

What commentators seem to be agreed upon is that the commodity price decline will hit emerging economies much harder than it will developed economies, which rely far less heavily on commodity exports and will enjoy many more of the benefits of cheaper oil, metals and other resources.

To buy or not to buy commodities

The question for investors is whether or not to include commodities as part of a diverse portfolio at the moment. Really, it depends on whether one feels the market has bottomed out or has further to fall, and unfortunately this remains unclear.

While the slide in commodity prices has certainly accelerated in the last month, to the point where it has become headline news, prices have actually been falling for the past four years. However, when you consider that in the ten years from 2001 onwards they boomed, it's likely they still have some way to go if this is indeed a correction in the market.

Michael McGlone, head of US research at ETF Securities, told Investment News: "Commodity prices are deflating and the implications are that there are virtually no signs of inflation in sight."

Yet there are those who take a less pessimistic view, who believe the recent steep sell-off is a sign that the bottom of the market is nearing and that now is a good time to make a move towards commodities.

Speaking to financial magazine Barron's, Scott Colyer, chief executive of Advisors Asset Management, said: "Now is the bottom of the commodity cycle. Nearly every central bank in the world is stimulating and trying to create inflation. That suggests it's time to be a buyer of the asset class and not a seller."


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