The concept of the ‘commodity super cycle’ was in vogue before the onset of the global financial crisis. The thinking was that an increasing world population and faster growing emerging nations, like China and India, would change consumption patterns and lead to shortages of many of the world’s scarce resources.
Seven years on, the world is a very different place. The global economy remains in a fragile state, while the upward price pressure on many commodities due to rising demand from emerging economies is more than being offset by increased supply. This has been very evident in the oil market, where excess supply has led to a collapse in prices. The dramatic price collapse was one of the main stories of 2014. Having reached a peak of $115 a barrel in June, oil prices fell 50% to $57 by year-end.
The fallout in oil prices could have major geopolitical ramifications. Russia, which is dependent on oil to support its economy, looks to be in particular difficulty, as the government tries to support the rouble and halt runaway inflation. A potential risk is a backlash from Moscow this year as they stoke up military tensions in Eastern Europe to try and quell domestic unrest and raise nationalistic sentiment. In the worst-case scenario, the Russians could refuse to repay their debt obligations which would send shock waves through the financial system.
Ultimately, some of the higher cost producers will go out of business and a new equilibrium price for oil will be set close to the global marginal cost of production of $70 over the next couple of years.
Gold is traditionally used by professional investors as a hedge against economic and geopolitical instability. But as the US economy continues to show signs of improvement and as the Fed gets ever closer to the first rate hike, the rationale for holding gold is less appealing. Although gold prices remained relatively flat in 2014, closing at $1,184 an oz., this followed a sizeable 28% decline in 2013. Precious metals appear to have lost their ‘safe haven’ status.