A sell-off in commodities, from copper to crude oil, over the past few trading sessions is telling some veteran market watchers that a slowdown in economic growth, likely one of considerable magnitude, is under way.
In the last two days alone, commodity prices seem to have fallen off a cliff. Copper futures, which tumbled 7.7 percent Wednesday, fell 1.8 percent Thursday, and have dropped 27 percent from their December highs.
Crude oil prices fell nearly 5 percent Thursday and have dropped almost 9 percent over the last two days, the biggest such decline since December 2004. The front-month futures contract was trading at its lowest level since June 2005.
In fact, everything from grains to base metals to livestock to cotton has been selling off over the past few sessions, notes Dennis Gartman, editor of the Gartman Letter investment newsletter.
“In all, it was an unseemly start to the year” for commodities, he wrote Thursday.
But why would this signal an economic slowdown?
Most commodities are used in the production of industrial goods. When producers start demanding fewer raw materials, it becomes noticeable in commodities prices much earlier than in official economic statistics, explained Barry Ritholtz, chief market strategist at Ritholtz Research & Analytics.
Copper, in particular, is often used as a reliable economic indicator because of its widespread use in production.
“Copper is the metal with a PhD in economics,” Ritholtz said. “It’s used in the wiring of homes and offices, in plumbing in construction, and it’s also a key component in electronic goods. When it softens, it means we’re making fewer homes, offices and computers.”
A fast-falling housing market and cuts in auto production took a toll on the economy in 2006. Gross domestic product slowed from a 5.6 percent annual rate in the first quarter, when it was boosted by a post-Hurricane Katrina recovery, to 2.6 percent in the second quarter and 2 percent in the third quarter.
The manufacturing sector contracted in November and barely grew in December, while retail sales over the holidays have investors wondering whether consumers are starting to feel pinched.
Similarly, the big drop in oil prices in recent months is raising concerns. Besides its use in plastics, oil is also used for the transport of goods across the globe, Ritholtz said.
Many market strategists look to transportation indexes, such as the American Trucking Association’s truck tonnage index, as indicators of U.S. economic health. That index plunged 3.6 percent in November, after a 1.9 percent drop in October, and it is at its lowest level since 2003, the trucking association reported.
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“November 2006 marked the single-worst month for for-hire truck tonnage since the last recession,” said the association’s chief economist, Bob Costello. “Both the month-to-month and year-over-year decreases indicate that the economic slowdown is in full gear.”
Yet few investors have picked up on most of these signals. While the market is debating whether the Federal Reserve will cut interest rates to stave off an economic slowdown, few are paying attention to the signals being sent by commodities.
“One would have to admit that the recent slide in copper’s price seems worrisome, yet there has been little discussion in the media about why this might be happening or its implications,” Richard Bernstein, chief investment strategist at Merrill Lynch, said in a recent note.
Merrill metals analyst Vicky Binns has predicted that copper could fall an additional 30 percent in 2007, while sector strategist Brian Belski lowered his rating on the materials sector to “underweight” on Wednesday.