Can Commodities Hold Onto Their Gains?

  • September 12, 2003
  • Edward Allen

So far this year, industrial commodities have performed quite well. For
instance, the JOC Industrial metals index (which is comprised of copper, nickel,
zinc, aluminum and lead)  is up 13% for the year. Some market observers,
however, question whether or not these gains can be sustained,  believing
that most of the recent gains in commodity prices are more the result of
speculative buying than anything else. But yesterday’s economic data suggests
that the price action in commodities is due to increased physical demand for
these goods (as opposed to investment demand), which, in turn, implies that
commodity prices can continue moving higher.

 US Exports.

Although the US is the world’s single largest consumer of commodities, US
manufacturing activity, which has been strengthening (durable goods orders are
now in a four month up-trend and ISM is above the 50 boom/bust level) by itself
cannot keep prices buoyant. In order for the yearlong rally in commodities to
continue, demand, and therefore economic growth, from abroad must also be
strong.

One way to gauge external economic activity is to look at current trends in
trade.  Yesterday, the US Census Bureau released Trade Balance data, which
includes the amount of goods that the US exports to the rest of the world, and
the figures bode well for commodity prices. To be sure, exports have been up
sequentially for four straight months and totaled $61.1 last month–despite a
stronger US dollar, which makes US goods more expensive. As can be seen in the
chart below, there is a strong correlation between commodity prices and the
amount of US goods sold abroad.

Due to the rise in globalization, many US based companies depend on outside
demand for their products. As a result, earnings and stock market performance,
can be affected by trends in global trade. Therefore, the four month increase in
demand for US goods abroad can be interpreted as a positive sign for the US
equity markets. The chart below illustrates the relationship between the S&P 500and US exports. 

 

Edward Allen