Falling commodities prices renew deflation fears

Commodity Price Drop May Change Fed Exit Strategy

The collapse in commodities has not gone unnoticed. Words like depression and deflation are again being talked about and it is possible that the commodity collapse in gold, copper and oil is sending an ominous warning about the direction of the global economy. Even more it may force global central bankers to reassess policy and fight what commodities are saying could be a major global economic contraction or at the worst a deflationary downdraft.

Those concerns were raised by St. Louis Fed President James Bullard, who believes that inflation is dangerously low. While Mr. Bullard says he does not use gold as a barometer of inflation, his comments seem to suggest that he should be. Fears that the Fed will have to abandon talk of an exit strategy on QE but may have to triple down to stop the economy from freezing up again. Bullard says that "People have been focusing on employment a lot but have maybe gotten a little bit blinded about the inflation numbers that have come in very low.”

Other central banks are on guard as well. The drop in price may reflect an economy that is drifting back into deflation caused by a stagnating European and Chinese economies. Slowing exports from Canada slowing growth and Japans yen printing that is trying to shock its economy out of deflation is adding to the global trade pressures. Add to that the possibility that the selling of gold by the Cypriot central bank is adding to the bearish sentiment. The reports of plunging European auto sales and weak exports from Canada could be a sign that the global economy is heading back into the abyss.

The problem also will impact not only central banks but commodity producers and the possibility that if prices don't stabilize then we could see major production cutbacks. Iran has already tried to call an emergency OPEC meeting if oil prices do not go back above $100 a barrel. Yet while we know that that won't happen, even the doves in the cartel have to be getting fearful as the price of oil get perilously close to their budget breakeven points. Bloomberg News reports that "OPEC will probably cut output if Brent prices keep trading below $100 a barrel because that's less than what many member countries need to balance their budgets, an inter-governmental Arab energy lender said. Oil prices must average $99 this year for the 12 members of the Organization of Petroleum Exporting Countries to be able to balance their national budgets, said Ali Aissaoui, a senior consultant at the Arab Petroleum Investments Corp., or Apicorp. "OPEC will definitely need to cut production to shore up prices as they can't produce at prices close to their breakeven level,” he said today by phone from Khobar, Saudi Arabia, where the bank is based.”

Yet can OPEC stop the freefall? With the United States now producing 80% of its own energy needs and an abundance of supply, an OPEC cut may not have the desired effect on the market that OPEC would hope. Not only that an OPEC price bump may be met with more demand drops that could cause another price and demand drop. Demand for Gasoline in the U.S. is at a 16-year low according to Dow Jones based on Energy Information Administration data.'

Yet talk that banks may act may be enough to slow the selling. In gold, record demand for coins and physical is giving hopes that we may see a bottom. If we see more talk like that of Mr. Bullard one of the selling points for gold that the Fed may exit quit sooner rather than later may change very quickly.

Brendan Conway of Barron's writes "For years, fund experts warned buy-and-hold investors against owning the United States Natural Fund (UNG), whose returns are tied to the futures market -- not to spot gas prices. But for a few months now, this exchange-traded fund has been working for people other than the fast traders who are its primary clientele. The fund is ahead by about 21% on the year -- that's only a few percentage points behind spot gas' 25% rise.

What changed? The futures market that drives this fund has, for the moment, gotten more benign for investors with a longer view. The change is that the phenomenon of "contango," meaning the upward-sloping curve of gas futures contracts that usually acts as a headwind against commodity-futures ETFs over longer periods, has flattened out. This flattening means it costs less to shift from one set of futures to the next. The factor causes UNG's performance to resemble more closely what's happening in spot gas prices.

“It wasn't that way until pretty recently. Last year, amid a steep contango in the futures market, the ETF fell 27%, even as the spot gas price advanced 15%. Things could shift back with little notice. But for months, they've been favorable.” A must read in Barons!

We have been bullish natural gas most of the year. We have been telling you about the gas play for some time now. We have for month been saying it is one of the best plays in the commodities markets! It may be time to act!

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.


Futures and options trading involves substantial risk of loss and may not be suitable for everyone. The information presented by The PRICE Futures Group is from sources believed to be reliable and all information reported is subject to change without notice.

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