Commodity prices a clue

Economists are lousy at predicting recessions. There is an old saying that economists have predicted nine of the last two recessions. But sometimes they are right.

In this column, let me highlight one danger signal most others have ignored. This is the sharp fall in commodity prices in recent months, something that often, though not always, precedes a recession. It certainly indicates falling demand and a global slowdown.

The price of Brent crude has oscillated up and down, but is currently at $82/barrel, down from a peak of $90/barrel in September 2023. Copper has fallen sharply from a peak of $5.1/lb this May to $4.06/lb. Aluminium is also down from $2,809/t this May to $2,310/t. Cotton has fallen from $101/lb in Feb to $67.8/lb.

Steel re-bars have fallen steadily from a peak ¥4,019/t last Nov to ¥2,950 today. In agriculture, soybeans are down from a peak of $1,405/t to $1,013, and wheat from $6.75/bushel to $5.35.

Warren Buffett‘s Berkshire Hathaway has sold stocks massively to pile up a record cash hoard of $277 bn in the last quarter. Perhaps he was influenced by the fall in commodity prices. He clearly fears that the good times have peaked and chances of a major decline have increased considerably.

US analysts have long worried that the US Fed has held interest rates too high for too long, and at some point this will have serious consequences, such as a commercial real estate collapse, which could plunge the country into recession. This didn’t happen in 2023, as some had predicted, but they now predict one in late 2024.

The warning indicator they cite is that the spread between a 3-month and 10-year treasury bill has become negative since Nov 2023. A large positive spread typically indicates good times, a zero spread spells risk, and a negative spread is often, though not always, an indicator of a coming recession.

Statista Research Group plots a chart of the likelihood of a US recession measured by the spread between the two kinds of gilts. The probability was as low as 4% in May 2023, but shot up to 70% in May 2024 (which, doubtless, encouraged Buffett to sell). It subsequently declined, but is still a shade above 50%.

The world economy is slowing. Geopolitics has fractured the global economy seriously, with individual countries putting up market barriers – above all against China.

If Donald Trump is elected as US president, he has promised a flat 10% tariff on all countries, plus 60% on Chinese products. This will provoke retaliation from all trade partners, leading to second- and third-order retaliations.

Global debt is also at unprecedented levels. Pessimists fear that at some point, investors will suddenly lose faith in the ability of major economies like the US to service their mounting debts at high interest rates, and rush out of bonds.

India’s own debt level is a high 80% of GDP, which may be sustainable. But it means that over 40% of all revenue disappears in interest costs, slashing funds available for investment or welfare.

A more urgent problem is that of inflated stock markets. The price-earnings (P/E) ratio in Indian markets used to be 18-20, but is currently 26 – just about the highest in the world, and higher than that of a stock as storied as Google (23.5).

At a national level, the US comes second with a ratio of 24.4. But valuations for some tech companies are astronomical – Nvidia (61), Tesla (56) and Amazon (40). Many fear this could be a bubble ready to burst. Nvidia’s price recently corrected by one third.

In P/E ratios, Japan comes third (16.7), followed by Britain (16.3) and Germany (14.7). China is far lower down at 9.0 and Brazil at 7.7.

You could argue that India deserves the top spot because it’s the fastest-growing major economy. You could also argue that this is a sign that the Indian market is more bloated than any other and, hence, more precarious and vulnerable to a crash. Gentlemen and ladies, place your bets.