FYI | Mar 07 2018
By Peter Switzer, Switzer Super Report
Are commodities warning us to be careful of a stock market crash?
Does a commodities boom run before a stock market crash, and, if so, what does it say about the futures for shares? This was a question Geoff Wilson of WAM, Paul Rickard and I were asked by an attendee at our Switzer Report webinar on Friday.
Geoff instantly looked at the GFC crash and noted that we’d had a commodities boom ahead of that brush with market devastation. However, he could not say he had noted a historical association of a commodities boom and then a market crash.
I didn’t have any ammo on the subject so I promised to look into it for today’s piece. So, this is what I’ve found.
The history lesson
You might have forgotten but when the likes of BHP saw its share price slump to nearly $14, there were experts tipping this commodity price crunch would set stock markets up for a crash.
On July 8, 2015 the AFR ran the headline: “China hurtles towards its own version of the 1929 market crash.”
The Fin really milked it for the major fear result.
“The parallels with 1929 are, on the face of it, uncanny. After more than a decade of frantic growth, extraordinary wealth creation and excess, both economies – America in 1929 and China today – are at roughly similar stages of economic development. Both these booms, moreover, are in part explained by extremely rapid credit growth. Indeed, China’s credit boom dwarfs that of even the “roaring Twenties”. Borrowed money, or margin investing, played a major role in both these outbreaks of speculative excess.”
Given that fear factor hyped up to near fairy tale proportions you can understand why commodity prices slumped but global stock markets kept creeping higher.
A mob called Casey Research thought this headline was timely in August 2015 with “These Stocks Go Up When Markets Crash” but they have jumped the gun on all of this trash crash-talk.
Ruchir Sharma played the fear card in April 2012 with the following headline in the theatlantic.com with: “The Next Global Crash: Why You Should Fear the Commodities Bubble.”
And this is what he led with: “Investors have gone crazy for commodities, pouring money into everything from oil to copper. Just like the world’s mania for tech stocks in the 1990s, this boom is headed for a bust.”
How do these big call merchants cope with being wrong for nearly six years? I know I’ve been right about being long stocks since March 2009, but I still cop criticism from the experts who are always looking for, and occasionally calling, the end of the bull market as we know it.
So we can have a commodities boom and a bust but still avoid a stock market crash, which shows you that shares have multiple reasons for rising and falling.
The best academic work I could find was by HO Zapata, Joshua D. Detre and Tatsuya Hanabuchi, who looked at the Historical Performance of Commodity and Stock Markets in the Journal of Agriculture and Applied Economics in August 2012.
They found that over the time period 1871-2010, stock and commodity prices had a negative correlation. Of course, they can go in the same direction, which happened from 2000 to 2008, but when stock markets crashed, commodity prices (very much due to China’s demand), kept rising until 2015, while a lot of stock markets struggled.
In fact the S&P 500’s kick up since 2015 has seen stock prices rocketing while commodities fell until 2015 and 2016 but both prices have been heading in the same direction since 2017.
In January 2016, fortune.com ran a tale about an upcoming bust pedalled by Albert Edwards, a strategist at Societe Generalle.
This is how fortune.com captured his scary market views.
“With the US stock market sagging, oil off to its worst start ever, and the China’s economy continuing to deteriorate, bearish analysts have a wealth of evidence to point to,” it told us. “Edwards predicts the US stock market could plunge as much as 75%. That would be worse than during the financial crisis, in which stocks from their peak to trough dropped a brutal 62%.”
Edwards has been a ‘forever bear’ predicting in 2010 that the S&P 500 was going to collapse to 450 but today it is 2,659!
So, what’s my take out?
No one can ignore the link in commodity prices and stock prices but there is no easy relationship to rely on. Clearly, you can’t ignore what commodities tell you but the story from this market is not always reliable for timing your exit from a stock market.
The current rise in commodities is good but it’s not a boom just yet. It is responding to a great global recovery, and watching how these prices go could be the canary in the coalmine for anyone working out when to reduce your exposure to stocks.
That said commodities can fall in price and other sectors — services-oriented ones — and companies making profits can still drive economies.
My job is to watch for believable reasons to buy or sell stocks and even though Donald Trump’s silly tariff strategy has to be watched as a potential problem for the global economy, right now the pluses for remaining long stocks still outnumber the negatives for dumping them.
If I see a commodity boom, and a bust seems likely, I would be the first to sound warning alarms but now is not the time for that.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
Content included in this article is not by association the view of FNArena (see our disclaimer).
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.