Why all commodities are headed lower
The CRB Index (officially known as the Thomson Reuters/Jefferies CRB Index) is a commodities futures price index originally calculated by the US Commodities Research Bureau in 1957. The index measures the price change for a basket of 19 common commodities: aluminum, cocoa, coffee, copper, corn, cotton, crude oil, gold, heating oil, lean hogs, live cattle, natural gas, nickel, orange juice, silver, soybeans, sugar, unleaded gasoline and wheat. Almost 40% of the CRB index comprises of energy commodities or petroleum based products. The CRB Index was designed to help analysts and governments track basic commodity prices and monitor price inflation of every-day goods.
Commodity prices tend to have very long cycles. In the 1970s, prices jumped sharply and peaked in 1980, increasing by 300% over an 8 year span. Starting in 1980, prices began to fall sharply and continued a slow decline through the 1990s, eventually hitting bottom in late 2001. The last secular bear market for commodities lasted over 20 years. Commodity bear markets are usually accompanied by (or more likely attributed to) weak economic growth, low inflation and are often marked by periods of recession.
In 2001, commodity prices started to climb just as the global economy began to pick up steam. Prices peaked in mid-2008, more than doubling the lows of 2001. This latest bull market lasted 7 years.
In 2008, collapse of the financial markets sent high-flying commodity prices crashing to lows not seen since 2002. Most commodities recovered as central banks around the world sent interest rates to record lows in an effort to stimulate inflation. Some commodities hit new highs in 2011, such as copper and gold, but most did not, such as crude oil. However, since 2011, all commodities have clearly been in a slow and prolonged downtrend, on average 50% from the highs of 2008.
Historically, commodity bear markets tend to be prolonged, measured in several decades. Prices initially fall sharply, then level off for a lengthly period where the index trades within a narrow range. In contrast, bull markets tend to be sharp and short, normally 7-10 years.
So what does this mean for energy prices, specifically crude oil? Although a lot of noise has been made around oversupply in the North American oil market, investors should make note that all commodities are declining in price. Although one can make different excuses for each individual commodity, weak global demand and contracting economies is generally the underlying cause of falling prices. And the current downtrend is likely no different.
Investors should also make note that secular bear markets tend to be prolonged and can last several decades. If the secular bear market in crude oil began in 2008, then we are likely barely half-way through this downcycle. History also warns that falling commodity prices tend to signal periods of global economic weakness. During the decline, expect prices to oscillate along the way, typically making lower highs and lower lows. However, investors are cautioned that any uptrend in crude oil (or other commodities) is likely to be short lived and part of a long-term downtrend.