 "Historically, rising rates have been good for commodities: Jodie Gunzberg")
As the US central bank, the Federal Reserve, seems likely to raise its key policy rate next month, there is nervousness in the global markets across asset classes — in commodities, gold and currencies, in emerging and non-US developed markets as well.
Jodie Gunzberg, global head of commodities, S&P Dow Jones Indices, in an e-mail conversation to Rajesh Bhayani, answers some questions on these issues. Edited excerpts:
Since the promising jobs report in October pushed unemployment down from 5.1 to five per cent, it is more likely the Fed will raise rates in December. However, inflation is still very low, at only 0.15 per cent. The contradiction sparks a great debate about the timing of a rate increase.
If the Fed raises rates before wages or prices truly increase, then they might (again) need to cut these rates below zero or buy bonds with newly printed money. On the other hand, the Fed can always raise rates at a faster pace if inflation accelerates faster than expected – that seems the simpler solution.
How will a rate rise impact commodities and capital flows?
Historically, rising rates have been good for commodities, for two reasons. One is that the return on collateral, a component of the total returns in commodities, increases as interest rates rise. The other direct and measurable impact of interest rates on commodities can be observed from the formal relationship between spot and futures prices. The theory of storage equation defines the futures price in terms of the spot price, the interest rate, the cost of storage and the convenience yield. All else being equal, commodities' futures prices rise as interest rates rise.
Industrial metals have been more sensitive to interest rates than precious metals from their economic sensitivity and term structures. For a gold bull market to form, high inflation and a weak dollar would be useful, in addition to higher interest rates. Plus, ETF (exchange traded fund) buying that takes physical supply off the market is a positive indicator.
Do you think (the) crude oil (price) has found a floor, as shutting down of capacities might be a hurdle for several US oil producers to restart when prices turn attractive?
The race has changed from one for land to a race for efficiency. Despite some production decline from the US, the oil industry has been resilient. The industry is different now than in past supply crises, as in 1998. Today, the low oil price has forced consolidation and merged companies are improving efficiencies to bring down the cost of production.
The increase in efficiency should bring oil production back faster than in 1998 or 2009 – some estimate as soon as nine months. A positive indicator of oil now is that the S&P 500 Energy Sector is outperforming the S&P 500 Energy Corporate Bond Index, meaning investors are more bullish than bearish for those companies. That sentiment, reflected by the spike in the energy equity risk premium, has followed other historical oil bottoms. So, the production might come back on line fairly quickly.
With lower oil prices, wealth is shifting from production countries to consumption countries. How has this impacted capital flows and currencies?
The International Monetary Fund now identifies lower oil (price) as the only upside risk to GDP (gross domestic product) growth, making impacts hard to know. The one point most agree on is that this oil drop is a chance for structural reform, despite policy differences in a world divided by importers, exporters, developed and emerging markets. For importers, it might mean reducing of subsidies and supporting of infrastructure growth.
Exporters might need to strengthen their monetary frameworks to avert depreciation and higher inflation and, then, further depreciation. The oil drop could boost demand in developed countries but more monetary policy might be needed to prevent real interest rates from rising, especially if there are further declines in inflation. In developed markets, increasing infrastructure investment might support a recovery and long-term growth. Unfortunately for emerging countries, macro economic policy to support growth remains limited but, in some cases, lower oil prices might alleviate inflation pressure.
The weather has helped (prices of) agricultural commodities to recover after a sharp fall. Do you think agri commodities have seen the worst?
Generally, the volatile weather brought by El Niño (the periodic weather disruption) has disrupted crop yields and pushed prices higher. For most agri commodities, price increases start happening soon after an El Niño. Cotton is the slowest to rise, taking over three months after El Niño periods to increase.
Wheat is the quickest to be impacted, with Kansas wheat gaining on average 72 per cent in the 12 months following El Niño periods. However, cocoa has dropped historically in the 12 months following El Niño periods, losing on average 35 basis points. It depends on the specific weather pattern impacting supply, individual demand models per commodity, perishability and storage capacity.
The dollar's strength has started taking a toll. How long could that continue and how will it impacting emerging market economies?
While commodities are generally negatively correlated with the dollar, some are more so than others. For example, gold, arguably more of a currency than a commodity, only has a slightly negative correlation to the dollar, between minus 0.3 and minus 0.4. The petroleum complex is most sensitive from its economic importance, with almost minus 0.7 correlation.
On the other hand, it is not surprising to see weather-sensitive commodities like natural gas, cattle, lean hogs and sugar with almost no correlation. Beyond weather, factors like transportability and the global usage (natural gas is local) might be more influential than the dollar's strength.