Bearish outlook for commodities
May 6, 2005
The gold price is holding up rather well. Except for a brief drop
to $410 an ounce in late January the gold price has held itself
above $420 this year with a slight upward trend in place. For the
past six weeks the gold price has hovered around $430 an ounce.
The US dollar is still on thin ice, and when it falls
through the ice the dollar-gold price will resume a more aggressive
upward trend. My bet is still that we will see $700 to $800 an ounce
within the next few years. But I am much less optimistic about commodities
such as copper, zinc, or nickel.
Keep in mind that gold is not a commodity: it is money.
The price of gold and the prices of other metals do not have to
follow the same path and, in fact, I don’t think they will
follow the same path going forward.
Being the largest economy in the world, the health
of the US economy is of paramount importance. I, and many other
analysts, have long belabored the huge amount of debt in the US
economy and how that debt will one day come home to roost. Let’s
take a look at some recent news headlines from the Wall Street Journal.
“Slowdown at U.S. Factories May Herald Further
According to a survey quoted by the Journal, the US manufacturing
sector turned in its slowest pace of growth in nearly two years.
The manufacturing sector has been slowing for five straight months.
I’m not going to rant about why the US economy
is in trouble. There are enough articles in the Commentary section
on my website at www.paulvaneeden.com on that topic. What I want
to point out is that we might be approaching the tipping point.
It is quite possible that the wobbles we are seeing now are the
wheels coming off. More headlines:
“Delta Puts Figures to Its Pension Bill”
It’s no secret that the airline industry is in trouble. Ever
since 9/11 they have been having a tough time and now, with the
rising cost of fuel, they are in serious trouble. But slow revenue
growth and rising fuel costs are not the only problems. One of the
really big issues facing the US economy, and not just the airlines,
is under-funded pension plans. Delta reckons that it has to pay
$3.15 billion into its employee retirement plans over the next three
years. That is in addition to the $450 million it will pay this
year. Let’s put that number in perspective. Delta had revenues
of $15 billion in 2004 but made a $3.3 billion operating loss. The
total loss for the year was $5.2 billion. Shareholders’ equity
in the company is a negative $5.8 billion. If you just add the money
that they have to pay into their employment retirement plans the
loss becomes almost $10 billion, and that’s assuming we don’t
have any more operating losses, which is a bad assumption to make.
It is not just the airline industry that’s in
trouble. Watch the auto manufacturers; they’re next. In fact,
most of America’s “Big Business” is in trouble.
But investors don’t care. The average price to earnings for
S&P 500 Index is 19.2 and the price to book is 2.8.
“S&P Downgrades GM Debt to Junk Status”
Talking about Standard and Poor’s, on Thursday they cut the
corporate credit ratings of General Motors Corp., General Motors
Acceptance Corp., and all related entities to junk status. S&P
also stated a negative outlook, indicating that a further downgrade
This is serious business. It affects about $300 billion
in outstanding debt and increases GM’s cost of doing business
across the board. You might not have known this, but GM is the largest
issuer of corporate bonds in the US. A harbinger? Possibly.
It’s not just Corporate America that’s
“Treasury is Considering Bringing Back Long
In August the US Treasury will announce whether it is going to start
issuing 30-year bonds again. During the dot com bubble and the stock
mania of the late Nineties the US Treasury was raking in tax receipts
from investors who making a killing on the stock market. The oracles
in Washington were so impressed by the addition tax revenues that
they decided to stop issuing 30-year Treasury Bonds. America’s
Government was going to start paying off its debt.
Of course, making future projections based on abnormal
circumstances is not prudent, and they should have known that the
financial environment during the late Nineties was unsustainable;
Alan Greenspan said as much in 1996 with his famous quote of “irrational
exuberance” in the US equities markets.
Instead of reducing its debt, the US Government is
going ever deeper into debt. Just this week the House of Representatives,
without voting, increased the US Government’s debt ceiling
by $781 billion to almost $9 trillion.
US interest rates have remained low to a large extent
because China, Japan, South Korea, and others, have been buying
US Treasuries with their trade dollars. But long term US interest
rates have also been kept in check because the Government was redeeming
30-year bonds and issuing shorter term bonds. If the Treasury decides
to reintroduce the 30-year bond in August, don’t be surprised
if 30-year interest rates start rising. I have long cautioned that
the US Budget Deficit is a virtual guarantee that US interest rates
will go up. The Government’s deficit has to be met by issuing
bonds. As the supply of bonds increases the price of the bonds will
decline, and interest rates are inversely related to bond prices.
So if bond prices fall, interest rates rise. By the end of this
year I expect we will see higher US interest rates across the spectrum,
not just on the short end, as we’ve seen in the recent past.
Of course, higher US interest rates are not going
to help Corporate America, or the consumers who are consuming more
than they’re earning. So none of this bodes well for the US
If the US economy slows down the rest of the world
slows down as well. The European Central Bank has said that growth
prospects in Europe have only worsened since the Bank downgraded
its forecast for the year in March. And who do you think is going
fuel China’s growth if both the US and Europe are having economic
On this backdrop you can see why I am not bullish
about the near term future for commodities. I suspect the cyclical
bull market in commodities is over. China is not yet in a position
to sustain its economic development with internal demand. If export
revenues stop rising at the pace of the past decade then China is
more likely to slow down than to increase it’s rate of expansion.
Now, we should not forget that there is almost universal
pressure on China to revalue its currency upwards against the dollar.
As I explained in my commentary of February 10 (available at www.paulvaneeden.com
in the Commentary section), a revaluation of the renminbi will cause
interest rates to rise and the dollar to fall. The falling dollar
will make the gold price in US dollars go up and it will mitigate
any decline in worldwide commodity prices in terms of US dollars.
So even though the price of copper and other metals might be declining
in many currencies, the price of copper in US dollars could appear
to be holding ground. Don’t let this fool you. The bull market
in base metals is not very likely to continue.
There are only two metals that I think have good upside
potential with acceptable risk: gold and uranium. I am, however,
becoming less optimistic about uranium. But that’s a story
for another day.
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