© Dr. Marcin Brycz
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In the beginning of 2000's commodities started its bull market following twenty year period, which is called ‘the Great Depression of Commodities'. Many investors pose the question how long the commodities, mainly oil, copper and gold will be in a bull market. On the other side we have an instant answer for this: emerging markets such as BRIC need more and more oil, copper, etc. Thus, prices will tend north. In my opinion, the emerging markets demand for commodities is not the only one long-run driver for its valuation.
At first let's look at the time when the market for commodities collapsed – the beginning of the 80's. At that time the Fed introduced tight money policy to fight excessive inflation and commodities, including gold, fell sharply. Oil, copper and gold had not broken its peak until the middle 2000's. In spite of good macroeconomic environment in the States in the 90's, oil and copper prices were moving in a horizontal band. Since late 90's commodities prices were in upward pressure, until Lehman's collapse.
After Lehman's collapse commodity prices tumble not only because of deterioration in the global macroeconomic outlook, but mainly due to deleverage. That is, holding long position was very expensive because short term interest rate was very high and markets experienced the ‘hunger for dollar'. In October 2008 the Fed came into action with its credit easing policy (not to be confused with Quantitative Easing policy). The objective for the policy was to decrease the 'hunger for dollar' (the Fed made repo operations with financial institution for non-performing assets – in other words the Fed lent money to financial institutions and took non-performing assets as a collateral). In November 2008 the Fed announced long-term assets purchase, and since February the Fed introduced Quantitative Easing policy for a large scale (buying long term assets – e.g. MBS, Bonds), till October 2009 asset-purchase was completed. The Fed implemented next round of asset-purchase in the first half of 2011 (QE2). In September 2011 the Fed introduced so-called Operation Twist, which objective is to change Yield Curve for T-Bond (Fed sells short maturity bonds and buys long maturity bond for the same amount). Operation Twist does not produce new money as it does the QE.
Summing up the short history of the Fed response to the crisis above we can divide it into tree stages:
i. Credit easing in October 2008;
ii. Quantitative easing I and II
iii. Operation twist.
These three stages acted in three different ways on the market. The objective for the first one was to fight with the market freeze between the banks and other financial institutions. The second one was to lower long-run interest rate by buying long-term assets and flood the market by new money. The third one was to steepen the yield-curve without flooding markets by new money. Manipulating the interests rate term structure is now one of the most important goal for the Fed's policy as the different interests rate are associated with the particular sectors of the national economy (this is clearly proofed in the Ben Bernanke and Mark Gertler famous paper: ‘Inside the Black Box: The Credit Channel of Monetary Policy')
Next we should try to find some link between the Fed's crisis response policy and commodities trends. We take the example of gold and oil prices. After Lehman's collapse all the commodities tumble, even gold. Usually gold is a safe haven, but that time its price fell due to the ‘hunger for dollar' and started to rise again in November 2008, when the market tensions eased. Oil prices started to rise when large asset purchase occurred, that is in February 2009. Since the first half of 2011, the end of QE2, commodities prices were in a horizontal trend.
Having the link between QE and commodities trend confirmed, we try to analyze the possible scenario for market situation. Markets expect the next round of QE, but it is not sure now what will QE look like. If Fed decides to extend Operation Twist it will not influence on commodity prices much. This kind of policy would only alter interest rate term structure that is decrease long-run interest and little change short run interest rate. When the Fed decides to buy additional assets and then enlarge the balance sheet, it will surly push commodities prices up by some 10-15% or so.
Puzzling question for longer run for commodities prices is when the 13-years old upward trend will reverse. In my opinion the Fed will give a signal, when it changes its monetary policy. Quite interesting are the minutes released on July 11, where policy-makers forecasts of the target federal found rates are presented. Till the end of 2013 it is not likely to expect any rise in the Fed funds rate, but in 2014 most of survey participants expect the interest rate hike and in the longer run policy-makers expect the funds rate to be 2.8-4.6 %.
Another issue is the developing situation in the EU. Deteriorating bond markets in Greece and Spain weigh on commodities prices much at least in the short run. If the situation go worse, the only solution would be the bonds purchase of contained countries by the ECB. If the ECB did so, we could expect some upward pressure for commodities.
Summing up the link between large scale asset purchase and commodities prices is quite observable. We should consider its influence on market prices especially in case when this policy is going to change seriously.