Will Commodities Fall?

In today’s turbulent market, we’re seeing some sustained trends emerge. One is the significant increase in commodities prices across a wide spectrum of goods that have seen values spike in recent months.

In commodities, everything from lean hogs and crude oil to gasoline and lumber is up – lumber, for example, is estimated to be up 50% in these first few months of 2021 alone.

That does all kinds of things to the new building market, and, by proxy, the housing market, and it potentially changes the plans of homeowners and big builders alike, because if they want to build anything, they’ll need to price in the increases with an escalator clause or some other method.

Why Did Commodities Soar?

Some of the higher commodity prices may be a seasonal effect, but many analysts believe that companies are stocking up on essentials. In some ways it’s similar to how consumers hoarded toilet paper in the first months of the pandemic.

It may be an overstatement to call it “panic buying” but amid news of commodities prices on the march, some of the activity that drives goods higher can be related to a self-fulfilling prophecy – companies restocking the shelves with inventory could have contributed to higher commodity prices. To put it another way, operational shortages can spike commodity prices, too.

With many restrictions water under the bridge now, consumption is rising for goods that had been less in demand during those dark months of the covid winter. So with the good news of new economic expansion, the market is pricing in the increased demand as well as the supply constraints which together are causing commodities prices to soar.

High Commodities and High Inflation

Many economics experts believe that commodities don’t necessarily respond to inflation per se, but that commodities are seen as a leading indicator of inflation.

Commodities can also function as a hedge against inflation. If inflation is happening to the dollar, those with dollars invested in commodities will typically see those values rise along with the greater dollar amounts (tied to goods) that are often present in inflationary markets.

How Does Inflation Affect Growth Stocks?

Inflation can also have a chilling effect on growth stocks. Here’s how that works.

One of the hallmarks of inflation is higher input prices. That leads to lower purchasing power among consumers. That’s a problem in more than one way. It might call to mind the hapless consumer bringing wheelbarrows of cash to the store to buy bread. But it also cuts growth off at the knees.

The result is that the market puts brakes on companies that formerly had bright prospects. Growth stocks fall very much into that category. On the other hand, analysts point out that value stocks often do well in inflationary markets, where growth stocks usually do not.

Will Commodities Fall?

With sky-high commodity prices in the first months of this year, some expect that commodity prices will eventually go lower.

Cathie Wood at ARK Invest is a prominent voice suggesting that there is a major correction on the horizon for commodities values.

In press statements, Wood explains her thesis: companies are stocking up on commodities causing a demand spike. Wood, who leads a company known for its investment funds, has quite a few people following her outlook for the market as investors flock to several flagship ARK fund – the ARK Innovation Fund (ARKK) as well as other ARK funds covering genomics, robotics and other particular areas of the tech sector.

“The scramble is more today than what we’ve seen in any other cycle,” Wood told Reuters, predicting a correction and characterizing the roller coaster that commodities have been on. “Many consider what has happened in the last three months to be the equivalent of the tech and telecom bust. We do not believe that this is the case in the least.”

If commodities do fall, as noted, it represents a correction of their prices in a fundamental way. These reversals often represent markets cooling off after speculative behavior in one direction has moved prices beyond ranges that they can naturally handle. We see, for example, that the Russell 1000 Value Index has trounced the Russell 1000 Growth Index by a factor of 3 or 4, showing that value stocks, which can benefit from high commodity prices, are moving.

How Far Could Commodity Prices Fall?

The short answer is: not very low. There is less arguably volatility in many commodities than there is in plenty of equities, cryptocurrencies and other investments where the value is largely tied to public perception of the underlying asset.

Indeed Nassim Taleb has pointed out that the recent rise in prices in commodities is in line with a random walk of prices that matches levels seen decades ago.

Commodities represent market trading of actual goods. That’s not to say that speculators can’t blow up the commodities market – they can, and they have in the past. But in today’s market, there’s some amount of stability and clear-eyed calm in the commodities market, as opposed to, say, crypto, where asset values soar to dizzying heights, and drop to stomach-churning bottoms, on any given day.

One helpful clue to how low commodity prices could go involves insight into past boom and bust cycles that determine results for commodity values.

Certainly, commodity prices may fall in the short term, especially if a glut of supply and weak or lackluster demand becomes evident. 

To the extent that you know your assets, you know better what to do in response to any type of short-term or longer term market cycle. Commodities famously swing higher ahead of periods of inflation so caution is warranted at this time. The reality is if they do fall, it probably won’t be very low during this cycle and may represent more of a correction than a bust.

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