After many months in denial, the world now believes that we are in the midst of the worst economic downturn in several decades.
Since last December, demand destruction born of the global contraction has been hammering commodity prices across the board. Falling prices have been significantly pulling down inflation expectations.
With more of this downturn before us, and since inflation is a lagging indicator, I think it likely that inflation and commodities including gold may fall for some time yet.
This should be a good thing. Inflation was uncomfortably high the past few years. Cheaper commodity prices will help the world economy re-stabilize. In the meantime however, the re-stabilizing of commodity prices will prove very destabilizing for producing nations that are now caught unprepared.
This is human behaviour up to its epic tricks. For the past 5 years, commodity and oil producing countries like Russia, Venezuela, Iran, and yes Canada have been living in a veritable fool’s paradise. Cash was pouring in and governments and their citizens took good times for granted.
Commodity prices soared with credit-fuelled expansion from 2001 to 2007, oil moved from $12 a barrel to $147, copper from .67 cents a pound to $3.90, and gold from $350 an ounce to $1,000. Notwithstanding these awesome price gains, many saw more increases as a continued sure thing. As an example, in drown-proofing expansion plans, many producers used $60 to $70 a barrel for oil as their worst case scenario.
In back of the envelope projections, some individual companies factored in $80-$90 oil as the baseline break even for future plans.
Today with oil testing $70 a barrel, copper at $2.00 a pound, and gold at $770 an ounce, world dynamics are now wildly in flux:
“Now, the producers are experiencing a reverse oil shock. As revenue went up, government spending went up and expectations of a continuing windfall led to greater and greater ambitions. Now they are finding how integrated they are into this globalized world.” See: 3 oil countries face a reckoning.
All of this is making an utter mockery of prior decoupling hopes.
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