Even though we’re less than halfway through 2016, this year is already shaping up to be one of the most bizarre on record for commodity traders.
At the beginning of 2016, it looked as if the commodity markets were set for another year of poor returns. Many key commodity markets were oversupplied, and China’s lacklustre outlook for growth didn’t suggest that demand would pick up anytime soon.
However in February, commodity prices started rising across the board for no apparent reason. The rally continued into April and reached fever pitch at the end of the month when enough cotton was traded in a single day to make over 7bn pairs of jeans while the price of iron ore spiked to a high of $70 a ton, up from $38.30 in December. In fact, the total value of iron ore futures traded in China during April hit $330bn, roughly four times the amount spent trading physical iron ore internationally in a year.
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It turns out China’s legions of private investors were behind this sudden surge in demand for commodities, and it looks as if the bubble has now burst. The price of iron ore has since fallen back to $55, and cotton prices have also come off their highs.
China’s speculative frenzy
Unfortunately, the rest of the world is now starting to feel the effects of China’s speculative frenzy, and this trend is most apparent in the mining sector.
Indeed, throughout the first quarter of this year, investors moved to bid up the shares of miners like BHP Billiton (LSE: BLT), Rio Tinto (LSE: RIO) and Glencore (LSE: GLEN) believing that, after a tough 2015, these miners were finally back on the road to recovery as commodity prices recovered. Between the end of 2015 and mid-April shares in Glencore had gained 75%, shares in BHP had risen 21% and Rio had gained 14.6%.
But since the end of April, these gains have been wiped out after the commodity price bubble popped. At the time of writing, year-to-date Rio’s shares are down 1.7% on the year, shares in BHP are up 5.8% and Glencore’s gains have shrunk back to 44%.
It doesn’t look as if the outlook for these miners is going to get any better either. Commodity prices continue to fall and according to Goldman Sachs, the recent surge in prices has lead to some miners delaying capacity cuts or restarting mothballed mines — a development that will only delay the market’s rebalancing.
The bottom line
So, it looks as if more supply is about to hit the market and at the same time, China’s growth rate is slowing, and the country is finding it harder to stimulate economic growth. Simply put, demand for raw materials is falling while supply is increasing.
With these worrying fundamentals overhanging the mining industry, it might be wise to stay away. What’s more, considering these developments BHP, Rio and Glencore all look expensive at current levels. Rio currently trades at a forward P/E of 19.8, BHP trades at a forward P/E of 79.1 and Glencore trades at a forward P/E of 35.1.
