Low short-term interest rates are pushing investors to move their money out of savings into other investments, and that money is likely to shift toward real estate or stocks rather than commodities.
"We may still have rallies in commodities," said Rich Nelson, director of research at Allendale, Inc. "But I'm concerned that maybe commodities won't be the next phase of investment," he said in a presentation to the Allendale Ag Leaders Outlook Conference Jan. 21.
Nelson described four major commodity price drivers:
- Supply and demand is the big issue, and "for the big picture, recession is bearish commodities." The recent recession led to a commodity price plunge, in line with the historical link of recessions to commodity markets.
- Exchange rates are closely tied to demand and commodity prices. The dollar index is primarily the dollar versus European currencies. If Europe experiences financial problems in coming months, the dollar will gain support. The dollar bottomed a couple of days after U.S. Navy SEALS killed Osama bin Laden. "This was a defining point," said Nelson "The mindset now is that we have a little confidence. We will not go down to those lows again on the dollar." The U.S. currency has been rallying and commodity prices have been falling since the middle of 2011. "A stronger dollar may give a negative bias, but it doesn't mean corn prices can't go up," said Nelson. The big U.S. debt and deficit will help limit dollar strength, keeping the dollar index perhaps in the 80 to 85 range.
- Inflation is limited and the interest-rate bias is downward for 10-year and 30-year Treasuries, said Nelson. Short-term rates already are near zero. Money will go toward investments that have prospects of beating that the inflation rate of about 3%. Commodities, stocks, and real estate are all prospects, but commodity prices peaked in mid-2011. "We are still in a risky phase of investment," said Nelson. "The Fed still encourages us to be in risky investments. But it may not be in commodity and farmland as much... Maybe to stocks."
- Economic growth and contraction offer mixed signals from different parts of the world. More below.
Bullish Signs from Asia
Gross domestic product growth is running about 1.5% in developed countries but it's more than 8%in developing nations of Asia.
Per-capita gross domestic product in the United States is about $44,000 per person. China's per-capita GDP is likely to rise from $13,970 in 2011 to $16,043 in 2015. "It’s not a lot of money, but it's 15% growth in income," said Nelson.
India's economic rise is even steeper. Per-capita GDP is expected to grow from $1,527 in 2011 to $2,153 in 2015. "A 41% increase in income per person is projected in India. That is astounding," said Nelson. "Imagine the change in mindset they’re going to have with a 41% increased income."
Population growth is also adding to demand, at a rate of about 2% in China and 5% in India.
"As far as the world picture, you can't be bearish on this at all," said Nelson.
Sluggish U.S. Economy
However, U.S. GDP grew about 1.5% last year, and one out of every six people is unemployed or significantly under employed.
"Economic growth is everyone's focus right now," said Nelson. "It is determining economic and monetary policy."
Some good news is coming from state governments, where recent data show revenues are recovering. However, federal government spending far exceeds revenues, and federal spending still accounts for 42% of U.S. GDP. The International Monetary Fund expects federal spending to keep at least a 40% share of U.S. GDP through 2016.
Consumer spending, as measured by personal consumption expenditures, gained at rates of mostly 2% to 5% from 1996 through most of 2007. Then it plunged to around a negative 3% in 2009 and recovered to about 2% recently.
"Even though they’re financially strapped and have a massive load of debt, consumers act like they feel better about it," said Nelson.
Huge Bank Reserves
Banks are holding nearly $1.8 trillion of reserves more than they need to meet regulatory requirements.
"There is a lot of money that is locked up that is scared now and not being lent," said Nelson.
How much control the Federal Reserve Bank has over 10- and 30- year rates is arguable, but he expects policies to encourage lending. "Interest rates should continue to push lower," said Nelson.