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STRATEGY FOCUS
Prepared by Merrill Lynch & Co.
Global Securities Research & Economics Group
Commodities Highly Impacted By Recent Events
In Asian And Other Global Stock Markets
The turmoil in Asia combined with volatile global equity markets was clearly the dominant influence not only in financial markets but also in commodities as well. Some have tried to make a bullish case for commodities as related to this but in our view the situation has mostly bearish implications. Asia is a particular focal point for many commodity sectors including base and precious metals and cotton but its impact spreads across the entire commodity spectrum and it has been clear that most markets have been dominated by these concerns while the particular fundamentals of individual commodities have taken something of a back seat.
The primary bearish influence relates to potentially reduced demand, not only from Asia but from North America, South and Central America, as well as Europe. The impact of the events in Asia is not likely to be confined to that region and all of the above areas should see some resultant contraction. Merrill Lynch Economics has stated “we suspect that 1998 growth in many areas will come in well below current consensus estimates. Japan remains moribund: We expect Japanese economic growth to be less than 1.5 percent in 1998.” U.S. and European GDP levels are also likely to suffer and Mexico is clearly threatened by currency turmoil. Various Asian currencies have been devalued including the South Korean Dollar and Taiwan Dollar. In addition, the Hong Kong Dollar peg has been under siege. All of this threatens potential global demand levels. China is also part of this equation with its growth rate likely to slow, albeit from a higher level. There is even some speculation that China will devalue its currency. Canada has suffered with its currency plunging to near 1.41 versus the U.S. Dollar despite steady intervention to support the currency by the Bank of Canada. The Australian Dollar has weakened significantly. When you put it all together, commodities are likely to be hurt by these developments.
Will Commodities Serve As An
Alternative Asset Class?
One contrary argument is that commodities will serve as an “alternative asset” class and as a result prices will have an upside bias. While we would not dispute the fact that some buying of this nature is possible, there has been little evidence of such activity to this point. Some hedge funds could potentially take this view but we expect no rush. In fact, some large hedge funds have been apparent sellers of commodities such as aluminum, zinc and cotton.
The base metals have been warning of a possible Asian meltdown for some time and the two most high profile base metals, copper and aluminum, have been weakened by prospects of reduced Asian demand. In recent days, you could predict the direction of the COMEX copper opening simply by noting what stock prices in Hong Kong and Tokyo were doing. Zinc has followed a similar pattern while lead, nickel and tin have been negatively influenced as well. It seems likely that this pattern will continue until there is a more stable atmosphere in Asia and global stock markets.
CRB Index Falls
The CRB Index has been falling during the Asian crisis which we view as a reflection of the outlook for lower economic growth and consequent reduced demand for commodities such as base metals, energy and some agriculturals. The CRB currently stands as 239.46 compared to 245.88 on October 22 and the Index is at its lowest point since August 26. The energy dominated GSCI has also suffered as it declined from 212.13 to 206.11 within a four-day period ending October 29. Slower global growth equates to lower energy demand an it is not surprising that this index has been pressured. Another widely followed index is the industrially oriented Journal of Commerce Index of Raw Commodities. Unlike, the CRB and GSCI, the JOC does not contain any energy, precious metals or agricultural components. Its purpose is specifically designed to measure the inflationary implications from the industrial sector. Given Asia's fairly dominant influence on industrial commodities, the JOC appears to be reflecting lower inflationary pressures emanating form Southeast Asia. Since mid- September, the JOC has lost more than 8 points to its current level of 104.50.
In summary of all the above we will put it simply, the current global currency and equity turmoil has bearish implications for most commodities. The mostly dismal performance in gold is an indication of this, although we view gold as a bear market on its own merits. Its lack of reaction to recent turmoil further reinforces this view.
October 30, 1997William O'Neill
Merrill Lynch & Co.
Global Securities Research & Economics Group
North Tower, 21st Floor
World Financial Center, New York, New York
Copyright 1997, by Consensus Inc. All American and Pan American rights Reserved. editor@consensus-inc.com
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