What Commodity Price Signals REALLY Mean For Investors

Man trading with multiple monitors

There is a strong optimism about the global economic outlook. The U.S economy is leading the list of indicators that global economic growth rates are set to remain on the rise at least for the next few quarters, if not years.

The bureau of economic analysis revised upwards U.S GDP growth rate for Q3 2014 from 3.5 to 3.9%, making it one of the fastest growing economies among developed countries. Analysts believe that the U.S economy could deliver a similar growth rate for the Q4 GDP, and possibly for the next few quarters, especially considering recent announcements from the Federal Reserve.

In October, the Federal Reserve announced the end of the quantitative easing program, which the department used over the last few years to revamp the U.S economy. This signaled a likely uptick in interest rates, which market players still believe could happen in the first half of 2015.

Last year proved to be a good one for the equities markets as the major U.S indices and ETFs notched record highs towards the end of the year. Some remain optimistic that the trend could carry on in 2015, but a few are questioning the reliability on the current economic recovery.

The commodity prices have dropped to multi-year lows, with oil in particular a key highlight among them. Normally a smooth economic recovery draws a significant backing from decent commodity prices. In other words, with commodity prices plunging, one can only conclude that the current rally in the equities market is driven by investor optimism.

On the flipside, the commodities markets appear to be presenting the true status of the global economy, or at least a clear signal of what might be coming in the next few quarters.

The significance of low commodity prices

The forces of demand and supply are clear. When the price of a commodity falls, this indicates that there is an oversupply of a particular commodity. Well, that’s one way of looking at it at least. But it can also suggest that there is a decline in demand in the market.

In the case of gold, silver, and oil, the latter scenario has been prevalent over the last few years. For example, despite an uptick in demand for gold, especially from India, China, Russia, and Japan, the overall statistical picture suggests that there is little demand for that commodity.

Other commodities such as silver, oil, copper, and iron ore are also facing the same problem. The decline in demand from major consumers, such as China, has contributed to the fall in prices of these commodities. However, investors are optimistic of a recovery in the Chinese economy, which would then boost global demand.

Based on this overview, it’s clear that the absence of demand for commodity prices is down to unimpressive economic numbers. The world’s largest consumers are holding back on their spending, which indicates some level of caution.

This means that the decline in commodity prices could be a better representation of the current health of global economies.

Let’s not forget that economic recovery does not necessarily mean that the economy of a particular country is doing exceptionally well. For instance, the U.S economy is growing by close to 4% on a quarterly basis, but the real picture suggests the quality of life in the U.S is far from the levels reached during the pre-global financial crises of 2008/2009.

The unemployment rate is well above 5% (currently 5.8%), while consumer spending remains relatively high compared to seven years ago. Therefore, investors should keep a keen eye on commodity prices because they appear to present the true picture of what could happen in the global markets in the coming quarters.

Conclusion

The bottom line is that, if economies are not spending, the gross domestic product is likely to decline accordingly. What we are seeing now is an impressive recovery from low economic levels heading towards the mean point, so to speak.

However, what happens after reaching the mean point is what should be of real concern to investors because this will signal the real economic growth from a wider perspective.

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