Author Clive James once commented on tennis star John McEnroe in the following manner:
"The Benson and Hedges Cup was won by McEnroe ... he was as charming as always, which means that he was as charming as a dead mouse in a loaf of bread."
For commodity investors, this past summer has been equally as charming.
In brief, since July 1st the TSX Energy Sub-Index is down 19.5% and the Materials Sub-Index is down a 29.3%. This compares to the first six months of the year where Energy was up 22.5% and Materials were up 25.6%. Building on several of the points (and several of the blogs) we've been making over the past few months, let's take a moment to figure out how we got here and where we go from here. As we see it, the drivers behind this tumble have been the following:
- An unwinding of the stampede into commodities, as reflected by the sharp pullback in energy
- The resurgence of the U.S. Dollar
- Concerns over a global slowdown, particularly in post-Olympics China, leading to a sector rotation away from resource stocks
In generally poor global equity markets, investors flock to what's "working" and over the last several months that's meant commodities. The better that trade worked (and it did work) the more money it attracted and the higher commodities were pushed (see Commodities are the new T-bills - June 20th for more details). Some of this "hot money" is now coming back out of the commodity complex and prices are going lower as a result. Although commodity stocks did not necessarily move in lockstep with the underlying commodities on the way up, they were supported relative to other sectors (see Oil UP, Natural Gas UP, Energy Stocks DOWN... HUH?? - July 4th), and now that support is slipping.
We have been positive on the USD for some time now (see "Reports of my death are greatly exaggerated" - US Dollar (with apologies to Mark Twain) - June 3rd), not because the U.S. economy is in such fabulous shape (it isn't), but because the rest of the developed world is in worse shape than most investors realize. With Europe and Japan now flirting with recession, contracting 0.2% and 0.6% respectively in the second quarter, investors have shifted their expectations towards lower interest rates in these economies and that has put pressure on their currencies and the USD has rallied as a result. While USD weakness exacerbated the run in commodities on the way up (see The Euro... making travel easier since 1999 - August 8th), USD strength will exacerbate the move to the downside. As they say in Monty Python and the Holy Grail, "I'm not dead yet".
The global economy is clearly slowing. China's economy has been the great growth story of the past several years (sorry India) and investors are now worried that the great China story is coming to a close (see Shanghaied in Beijing - July 11th). We would disagree. The emerging economy infrastructure build-out that we're in the midst of is a multi-year phenomenon and while the pace of this build-out will ebb and flow over the years, it is far from being over. During the slow periods investors will shift their attention elsewhere and sector rotation will occur (see And the first one now will later be last, for the times they are a-changin' - Bob Dylan - July 25th)
While these drivers have battered the resource sectors over the past couple months, we view the recent price moves as a return to normalcy, instead of the end of the commodity story. As any trader knows, markets never move in a straight line, and this situation isn't any different. If anything, resource stocks are looking increasingly attractive as they price in ever-greater pessimism. Does that mean we're going to have a sharp recovery tomorrow? No, but as longer-term investors, we expect that this too shall pass.
In other news...
Alan Greenspan has been accused of missing a few bubbles during his tenure at the Federal Reserve (dot com, real estate, etc.) and he was a pretty sharp guy. So how do we protect ourselves from the next great bubble bust? Well, we start writing lists on where the next bubbles might come from, and perhaps, just maybe, that will help us avoid them. Hope springs eternal.
I assure you, we're quite serious.