cmdtyInsights Weekly Commodity Market Report

Commodity price outlook depends in part whether the stock market correction worsens

The Bloomberg Commodity Index (BCOM) since mid-December has shown a fairly strong correlation with the S&P 500 index, as seen in the nearby chart. BCOM rallied sharply starting in mid-December and reached a peak on Jan 25, one day before the peak in the S&P 500 index. From their respective January peaks, BCOM has fallen by a total of -4.7% while the S&P 500 index has fallen by a much larger -10.2%.

The sell-off in stocks has been bearish for commodity prices because there is concern that the extreme volatility in stocks may cause uncertainty among businesses and consumers, thus causing weaker economic growth and weaker demand for physical commodities. In addition, the stock market is seen as a general barometer of economic conditions, which means that weakness in stocks could indicate some impending obstacles for the economy and corporate profits.

The sell-off in stocks has also been bearish for commodity prices since it has likely prompted some investor selling of commodity funds. Commodities are a fairly risky asset class and the current risk-off investment climate encourages the movement of capital from commodities to cash, or at least to less risky assets.

However, the recent weakness in commodities isn’t solely due to the stock market sell-off. Commodity prices have also been pressured by persistently high interest rates and the +2.4% upward rebound in the dollar index seen in the past two weeks.

The S&P 500 index has so far corrected lower by only -10.2% from its record high. There is plenty of room for the S&P 500 index to fall farther from current levels and still remain in just a corrective mode. Further weakness in the stock market would undoubtedly cause additional weakness in commodity prices.

By contrast, if the S&P 500 index has already seen the bulk of its downside correction and chops sideways in a consolidation mode in coming weeks, then commodity prices should stabilize as well. In that case, the focus in the commodity markets will return to the supply/demand factors affecting each specific market.

Indeed, crude oil prices on Wednesday fell sharply due to the market-specific factor of this week’s EIA report that showed the second weekly increase in U.S. crude oil inventories and a 47-year high in U.S. oil production.

The longer-term commodity outlook remains favorable due to strong, synchronous global economic growth, which implies strong commodity demand. However, commodities are still subject to downside risk factors such as any further weakness in stocks, a continued rise in interest rates, or any significant upward rebound in the dollar.