My Market Observations

Why commodity prices are falling

skoh888
Publish date: Sat, 02 Jul 2022, 02:04 PM
I watch and trade markets based on observation and logic. Leave the emotion and ego at the door and you will survive!

Markets in all assets had a brutal sell off in June, Everything from stocks, commodities to even crypto currencies were not spared. What was the catalyst behind the sell off? Aggressive interest rate hikes by the Federal Reserve in the last FOMC meeting.

Spiraling Inflation

The inflation rate has been getting out of control and has reached levels where it is of great concern to the Federal Reserve. So in its June FOMC the committee decided to do the unthinkable and raised interest rates by a staggering 75 basis points. the biggest increase since 1994. This was the catalyst that triggered the sell down in the second half of June. It has also telegraph its intention to the markets that another 50 to 75 basis hike is on the cards for the next July meeting as well.

Agriculture commodities prices are tanking

We have a saying in the business where you never fight the Fed. Inflation this time around was brought up mainly by supply disruptions caused by the Russia Ukraine war. There was no real increase in demand for commodities in this latest bull cycle, unlike the 2008 commodity market which was driven exponential growth in China demand. So raising interest rates aggressive will cause demand destruction and will help bring inflation down to the Fed's target rate of 2%.

As of 1st of July all agriculture commodities which had a bumped up in prices have given back all its war premium and are falling fast. Back home we have CPO prices tumbling 4% yesterday trading at RM4703 and its way off the high reached on March 9 at RM7268, down a staggering 35%. Over at the Chicago Mercantile Exchange last night we saw everything from soybeans to wheat dropping over 4% in a session to close at 4 month lows. Wheat which was the biggest mover as a result of the Russia Ukraine conflict settled 30% lower from the levels reached in March at the start of the incursion.

What this means for the economy

Jerome Powell in the text of his speech has also mentioned that sparking a recession is something that the Federal Reserve aims not to do but it is increasingly difficult. So is a recession if it happens really very bad for the stock market? Actually in boom and bust cycles of the economy, recessions are very normal and is a normal course of nature to neutralizes excesses that were created during the era of easy money and also to weed out weak businesses.

The question then is how fast we get out of the recession if we get into one. The best case scenario is a V type scenario where we endure some pain but it perhaps last anything from only 6 to 12 months. The one that we want to avoid is the L shape one like the one experienced in Japan in the 1990s where the economy and stock market stayed slumped for years.

My personal view

I am of the opinion that we will enter a recession phase soon but the good news is I believe that it will be a V type of recovery as the Federal Reserve has been very proactive and made this bold move to stamp out inflation quickly. The aggressive rate will no doubt hurt many business and man on the street but it is the best way to ensure that we crimp out all the excesses and tackle the issue quickly.

Stock markets tend to be forward looking and discount most events 6 months in advance. So if one believes that we will get a V recovery, the current weakness and perhaps a bit more weakness in the weeks and months ahead  may serve as a good buying opportunity. For now asset allocation and risk management are the keys for survival in these uncertain times



Discussions
3 people like this. Showing 39 of 39 comments

wallstreetrookie

ISM Manufacturing numbers are bad but within expectations. Chinese supply chain recovery will probably bring inflation down by mid third quarter of 2022. Once inflation comes down, global CPI and headline inflation will plummet, bringing the global economy into a recession.

Commodity prices no longer move based on economic data. Crude oil together with vegetable oil (palm oil, rapeseed oil) prices go up due to geopolitical conflicts and political crisis (Russo-Ukrainian war). We are in the mid stage of a "commodity supercycle". A "commodity supercycle" usually lasts a decade, and we are merely 3 years into the cycle.

So, calling a significant drop in commodity prices is too EARLY and presumptious. You need to come up with better statistical models to forecast the prices with strict parameters and not just rely on economic data at this point. US recession probability in the next 12 months is inching towards ~approx. 45% and BoFA numbers are even higher. This will probably not be the case for Malaysia because inflation numbers are lower.

In essence, both of these scenarios are bad for the market. The best play right now is to hoard cash and allocate assets to fixed deposits and interest rate swaps (a bit too late to hedge). Commodity hedge arbitrage is very hard because the window of opportunity is getting tighter. Avoid anything until ISM Manufacturing index recovers and the next quantitative easing by Bank Negara (which will probably never happen for the next 5 years).

1 month ago

Sslee

One of the biggest contributor of industry and agriculture output cost is energy and fertiliser cost. EU will fall into recession as their industries and agriculture cost will be very high for years to come if EU insist on cutting off cheap oil, gas, eletricity and fertiliser supply from Russia.

1 month ago

sherlockman

Thank you for another insightful article with a good macro overview!

1 month ago

qqq3333

comments are useless................................. anyone younger than 60 have not seen a recession.

1 month ago

positiontrader

skoh888 personal view

I am of the opinion that we will enter a recession phase soon but the good news is I believe that it will be a V type of recovery as the Federal Reserve has been very proactive and made this bold move to stamp out inflation quickly. The aggressive rate will no doubt hurt many business and man on the street but it is the best way to ensure that we crimp out all the excesses and tackle the issue quickly.

Stock markets tend to be forward looking and discount most events 6 months in advance. So if one believes that we will get a V recovery, the current weakness and perhaps a bit more weakness in the weeks and months ahead may serve as a good buying opportunity. For now asset allocation and risk management are the keys for survival in these uncertain times

My comment:
Accumulation now should be for wealthy Investors who have millions or billions to invest
But for retailer investors, this is not a best time to collect. Stay out of the market and save your bullets for cheaper price down the road.
Cheers :)

1 month ago

StartOfTheBull

The Ukraine -Russian conflict triggered panic buying of commodities and prices were pushed to historical high.
Now that importers of commodities, palm oil, wheat and other soft commodities in particular have temporarily slowing down their purchases pending for the completed shipments and clearance of their inventories.
Once they are about to use up their stocks they will start buying again and cause another round of CPO price upsurge.

1 month ago

anthonytkh

Well Skoh, you know my stance. Right?

1 month ago

anthonytkh

You see, I’m always guarded about the word “recession”. Can it be mild?

Whatever degree or extent it becomes, I just go look at certain counters namely those that women usually like to display (but men tend to frown upon *except* for trading, haha)

1 month ago

skoh888

Thank you all your comments and views to make this article the most read for the weekend! Much appreciated! As for the stock markets, there will still be winners to be picked but from a bottom up approach. Stay safe and have a good week ahead !

1 month ago

Raymond Tiruchelvam

thanks for the enlightening write up skoh888... and to add recession is defined as 2 continous quarter decline in GDP. There has been no decline as such, and even if it starts in say july so we will actually know only by dec 2022. The world just go out of covid doldrums and therefore we cannot afford to get into a recession so soon. The hike in prices or so called inflation was brought about by high energy prices, stemming from no doubt russia ukraine war, but also demand picking up after covid. We shd be aware of this fact and therefore the so called inflation can partly be explained due to the increased demand. Anyone aiming to reduce inflation can only reduce the portion which is artificially induced by middle man etc but not the part which is fundamentally there due to demand rise after covid. Just my 2 cents.

1 month ago

skoh888

@raymond...thanks for the comments. Yes you are right by definition we need to see 2 quarters of consecutive decline in GDP to confirm a recession. However by the time u get confirmation of the data the stock market would have already priced that in

1 month ago

skoh888

So the real damage to the economy and stocks would have already taken place in the 2 quarters precedent to the confirmation of data and reacting to the confirmation of data may be too late

1 month ago

skoh888

Stock and commodity markets are about pricing in expectations of the future so we must use better matrix as traders and investors to stay ahead of the curve

1 month ago

speakup

pump & dump mah
what goes up must come down mah

1 month ago

wallstreetrookie

Recession probability is 30% - 45%. I have no idea what the recession risk in Malaysia looks like because Malaysia is already in a recession

1 month ago

skoh888

CPO futures is currently down 7% ..

1 month ago

DickyMe2

Simpleton argument by just using coffee.
The author conveniently avoided the wastages government makes by bailing out useless companies. Providing discounts, scholarships and feeding entitled people from cradle to graveyard. Gigantic and comatose civil administration which is also cost. There are many leakages in the system.

1 month ago

sherlockman

A very well timed article. All commodities crashing, crude oil down 9% soyaoil down 7%! good call! saved al lot of money for those who sold their plantation stocks last 2 days

1 month ago

skoh888

@sherlockman....thanks;) yes I really do hope some people benefitted from the article

1 month ago

ahbah

Everything is falling, my portfolio is also crashing !!! What to do now ?

1 month ago

BILLC

To be precise,,,everything is rising except your portfolio and stock markets,,,,,hahaha,,,,

1 month ago

ahbah

I got to cry n accept your writing. Pain is all around me !!!

1 month ago

DickyMe2

Recovery is far away. Late 2024.
RIP.

1 month ago

i3gambler

I believe big profit margin of any business will not last for long.
Same to loss making (price below of cost) also will not last long, unless we no longer need that product.

That was why when I evaluate plantation companies, I predict the price will soon converge to 10 years average (net of cost increment).



1 month ago

treasurehunt

Commodity prices are repeated its cycle as usual and largely depending on FED actions and QE/QT.

1 month ago

ahbah

I hope DickyMe2's prediction will not come true.

1 month ago

ahbah

Today, we got a veri painful day. Is it due to the OPR hike by BNM ?

1 month ago

ahbah

Mani other foreign mkts also kena teruk like ours.

1 month ago

treasurehunt

Mana ala masa main silat ‘falling knives’. Koyang kaki tengok wayang cukup la.

1 month ago

treasurehunt

Cheap money is crucial to initiate pumping activities especially commodity products. Waiting for another round of QE to boost the commodity prices… early 2024?

1 month ago

ahbah

QT no got finished yet, oredi got coming QE again so veri fast meh ?

1 month ago

StartOfTheBull

Interest rate hike is used to discourage spending, the demand is basically unchanged. Quantity Easing would not likely be able to boost commodities prices, only increase in demand can. Another round of QE would possibly push down the interest rate instead and boosting the equaties market, it actually cannot help to build a healthier economy.

1 month ago

AlsvinChangan

Everything can be trace back to USA

reccesion risks 100% USA fault for messing with interest rate

inflation 100% USA fault for messing with CHINA export

USE interest rate to fight inflation?

INCREASE interest rate so that MADE-IN-CHINA will become cheaper ?

1 month ago

VTrade

Comodity relate to resesion?

1 month ago

AlsvinChangan

Comodity relate to inflaktoin?

1 month ago

StartOfTheBull

When buying power exceed supplies it cause inflation. Supplies may include goods and services for example commodities and transport. Increase in per capita income of a country is one of the main factors that cause inflation.
Just a bit of my sharing, I am learning from you guys too.

1 month ago

StartOfTheBull

Recession leads to business activities slowing down. Properties is likely the hardest hit, not soft commodities for example wheat, including our favourite roti chanai.
Just a bit of my sharing, I am learning from you guys too.

1 month ago

VTrade

US wakil kata kena ignore cpi data bulan 6
Itu data dulu zaman purba.
Minyak sekarang cheap cheaper

1 month ago

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