With stock markets around the globe off to the races again this year it seems as if all risk assets are climbing relentlessly. It turns out commodities aren’t quite as buoyant as their equity neighbors. Recent positive economic news including U.S. housing growth, a pickup in manufacturing activity and avoiding the fiscal cliff has helped stocks more than commodities. The MSCI World equity index has jumped over 13% since its November lows, while the relevant CRB commodities benchmark is up only 3.9% for the same period. Perhaps the party is finally over for the decade-long commodity supercycle largely driven by China’s insatiable demand for raw materials to build infrastructure and residential housing (see chart)? Or the U.S. shale discovery boom in oil and gas combined with a looming iron ore surplus has cast a shadow over the commodities market? This may be the case but we suspect there will be renewed demand for commodities from developed markets with crumbling infrastructure, or fast-growing emerging market nations in the future.
But what accounts for the recent lag in commodities? The correlation between these two assets classes has been falling as the level of fear subsides in the market. When volatility rises and investors are fearful, most asset classes will trade in unison, rising or falling together. During times of calm (i.e. VIX index < 15) assets tend to trade independently and underlying fundamentals play a more dominant role in the direction of prices. This week’s chart demonstrates the bifurcation of stock prices from commodities beginning in early 2012 when the CRB first fell behind.
Given Canada’s commodity-driven economy, we fear our market’s relevant outperformance to the U.S. has officially come to an end. We see more tailwinds behind the sails of the U.S. economy and have concerns about housing, banking and a sustained commodity demand slowdown at home.