Commodities and U.S. stocks have diverged in level terms only twice over the past 10 years and in both cases the divergence lasted nine months. Is the current divergence more sustainable?
B road commodity prices have fallen over 25% since their April 2011 peak, representing the largest non-recessionary sell-off since the bull market in commodities began a decade ago. Alongside commodities, stocks also peaked in April of last year, likely due to tensions in Europe. But while stocks recovered at the end of last year in anticipation of a policy response from the European authorities, commodity prices continued to decline as the pace of Chinese economic activity eased amid restrictive policy.
True, China recently started easing, but the scope of their stimulus is still not big enough to convince financial markets that a more pronounced slump in economic activity can be avoided. Concerns about Chinese growth and the escalation of the European crisis has pushed commodity prices into deeply oversold territory. The extent of the decline in commodities that has already occurred suggests that this asset class will not be able to diverge from stock prices beyond the near-term. A catastrophe in Europe or a riot point sometime by year end due to the U.S. fiscal cliff could force equities to follow the path of commodities.
An alternate scenario is that commodity prices begin to recover in the second half of the year as China’s soft landing comes into focus.
In either case, we deem it too early to play a reversal in commodity prices as the near-term backdrop in China, the U.S. and Europe is too uncertain.