The Strong Dollar Weighs Heavily on the Commodities Market

Commodities suffer from slumping demand—and the robust U.S. currency
Photograph by Jonathan Kitchen/Getty Images

Early in 2014, the commodities markets were doing surprisingly well. China’s appetite for raw material was holding up, and the International Monetary Fund was predicting a decent year of global growth, which meant rising demand for everything from oil to cotton. Then the spell broke. In July, China reported lower imports of oil and copper. Since the country is the largest consumer of pretty much everything that’s pumped or mined out of the ground, the news sent prices of commodities sliding. On Oct. 2, oil fell below $90 a barrel for the first time in 17 months. Global growth was stalling, and the commodity companies were faced with much lower demand than they’d anticipated in January.

The biggest problem is that China’s stimulus measures have failed to boost economic growth. The first three rules of commodities demand, according to Quincy Krosby, a market strategist at Prudential Financial, are “China, China, China.” The last decade’s spectacular rally—evidenced by the Bloomberg Commodity Index, which almost tripled from the start of 2002 through 2008—hinged on double-digit Chinese growth, she says. That pace has fizzled now that the world’s second-largest economy is heading for its slowest expansion in two decades.

The China-led runup in prices spurred investments in new iron ore, copper, and oil production that have come to market just as growth has slowed. The IMF in early October reduced its forecast for global growth in 2015 to 3.8 percent, down from a July prediction of 4 percent. “Global economic growth has petered out in a way that nobody had anticipated at the beginning of the year,” says Ed Morse, Citigroup’s head of global commodities research.

Aggravating the commodities slump is the strong dollar, buoyed by the fairly robust state of the U.S. economy compared with the rest of the world. That poses a problem for developing economies, which are big consumers of commodities such as the iron ore and copper they use to build infrastructure at home and manufacture goods to sell abroad. The dollar is up 5.6 percent since June 30 against 10 leading currencies. Because the global trade in commodities is conducted in dollars, developing countries with weak currencies have to spend more for the commodities they want.

Commodity prices advanced early in 2014 as drought in Brazil spoiled coffee crops, a cold snap in the U.S. drove up demand for natural gas, and war in Ukraine sent investors fleeing to the perceived safety of gold. Those factors have since disappeared or reversed themselves. Oil traders expected violence in the Middle East to disrupt supplies, but the disruption never came, and the world got an oil glut instead. American farmers followed up the worst drought since the 1930s with bumper crops of corn and soybeans. Stubbornly low inflation dimmed the appeal of gold. “The idiosyncratic factors that were boosting a lot of the markets earlier this year—the weather, for example, and even geopolitics—they’ve all faded away,” says Kevin Norrish, a commodities analyst at Barclays. Exceptions include coffee, still facing a shortfall in supply; beef, as a drought in Texas has shrunk the state’s cattle herd to its smallest size in at least 60 years; and cocoa, because of concern that the Ebola outbreak could spread to Ivory Coast, the top exporter.

The historic expansion of U.S. oil production, thanks to fracking, is also contributing to the decline in the price of oil as supply outpaces demand. The greenback draws strength from domestic oil production, which is at a 28-year high, reducing imports and narrowing the trade deficit. Saudi Arabia, Iraq, and Iran have cut prices rather than production: They’d rather let the price fall than lose market share. They may also be trying to drive out higher-cost U.S. producers, T. Boone Pickens, who made billions trading oil, said recently.

U.S. consumers are cheering cheaper oil. If prices stabilize at current levels, the average household will get the equivalent of a $600 annual tax cut, Citigroup’s Morse estimates. Regular unleaded gasoline now averages $3.18 a gallon, the lowest it’s been since February 2011, according to AAA. Producers, however, face investors’ wrath, because falling prices erode cash flow, making it harder to repay oil companies’ debts and potentially rendering new drilling unprofitable. The Energy Select Sector stock index has dropped 18 percent since Aug. 29, compared with a 7 percent decline in the Standard & Poor’s 500-stock index.

Some commodity producers have announced cutbacks, including Rio Tinto Group and BHP Billiton, the biggest miners. Commodity consumers such as Delta Air Lines (jet fuel), Gap (cotton), and J.M. Smucker (soybean oil and peanuts) have said they’re benefiting from lower costs. The problem is that the stronger the dollar gets, the cheaper commodities appear to Americans—and the lower the U.S. inflation rate gets. But that just makes the dollar even stronger. “There’s a feedback loop,” says Mike Wittner, Société Générale’s head of oil market research. That loop will be negative for some time to come.