As U.S. retools, commods, emerging markets lose: James Saft
By James Saft
(Reuters) – The rebirth of U.S. manufacturing may be the key which unlocks the puzzle of the divergence of commodity prices from equity markets.
If so, commodity prices may be in for more pain, U.S. growth may be better than expected over the longer term and U.S.-based companies stand to reap the benefits.
One of the most interesting trends over the past two years is the way in which agricultural, metals and energy prices have trended downward even as equity prices rise. This is especially hard to reconcile given that economic growth, while only moderate, has been positive. The Thomson Reuters CRB index of commodities and energy has fallen about 10 percent since last September, during which time Germany’s DAX is up 14 percent, the S&P 500 a bit more and the Nikkei 225 a whopping 50 percent.
It is certainly true that equities have been helped by official intervention, with the Bank of Japan and the Federal Reserve in full quantitative easing mode and the European Central Bank standing behind its pledge to save the euro. Still, though the support might be more diluted, why would commodities and energy be less susceptible to QE than equities?
In part, argues Manoj Pradhan, economist at Morgan Stanley, this is a supply side story, but more interestingly it is also about a huge structural shift under way in the global economy.
“The persistent indifference of commodity markets and the exuberance in equity markets is better explained from a fundamental point of view, by considering the changing balance of global manufacturing,” Pradhan writes in a note to clients.
“Reindustrialization of the U.S. economy means that it is likely to return to sustainable growth as a competitor for EM economies rather than the consumer of EM exports it has been for the last five decades.”
RESOURCE INTENSIVE EM
The reasons behind a U.S. revival of manufacturing are many. Wage differentials are now much lower than they were five, 10 or 20 years ago. As well, the discovery and exploitation of huge new supplies of energy in the U.S. gives manufacturing there a price advantage, one which is only increased by quicker time to market and lower transportation costs.
And finally, new technology, such as 3-D printing, is re-writing the rule book on the global supply chain, making it easier to manufacture closer to where consumers are. As opposed to old fashioned metal-bashing, which makes items by hewing them out of raw materials, 3-D printing involves literally spraying items into being out of plastics and other materials. Given that more of the value of a 3-D printing operation is in technological intellectual property, there are also good reasons to place operations in locations where enforcement of IP laws is more robust.
And quite apart from cutting-edge technologies, cheaper energy may allow it to move downmarket to compete with China and other emerging markets.
But why would a dollar of steel or a widget made in the U.S. require less in the way of natural resources? In part it is because, as woeful as U.S. infrastructure may seem, new production there will require little of the sort of massive emerging market projects we’ve become used to, and which have driven demand for steel, oil and much else.
As well, higher labor costs in the U.S., as well as a relatively higher cost of capital there (as compared to China) means more of an emphasis on efficiency in all things, including the use of commodities. Bad news for future employment, perhaps, but good for U.S. tax revenues.
If in fact it is U.S. manufacturing which is driving down commodities prices, then we should expect to see more of the same in the future. The shale oil revolution and 3-D printing are trends, which while well known, are likely in their early stages.
That’s bad news not just for the prices of the commodities, but for countries like Australia, Russia and Brazil which have become perhaps overly reliant on strong international demand for what they can grow and dig up. How that plays out over time will be complex, but could have an impact on everything from currency prices to the cost of a lovely condo overlooking Sydney Harbor.
The reverse is also true. All else being equal, U.S. Treasuries are probably a better bet in a world in which the country not only enjoys energy independence but is making and selling more goods at home.
To be sure, this is a long trend, and one which could be slowed or reversed by many factors, from domestic concerns in the U.S. to a leveling of the energy playing field by new discoveries elsewhere.
There will be huge winners and losers, but over five or 10 years there are good reasons to be mildly cautious about commodities and mildly optimistic about U.S. assets.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)