US Data Contributes to Commodities Sell Off

Posted on : Mon, 16 May 2011

Recent economic data from the US has been mixed, but has contributed to a sharp correction in commodities and a roller coaster depreciation and appreciation of the US dollar, according to analysis by QNB Capital.

The real GDP growth rate of the US economy slowed to 1.8% in the first quarter of this year, compared with 3.1% in the last quarter of 2010, according to preliminary estimates released by the US Department of Commerce at the end of April. Government spending contracted in the first quarter and will continue to act as a drag on the economy.  However, an increase in personal consumption by 2.7% was higher than expected. Growth in this area may lift the rest of the economy later in the year, suggesting that the slowdown in growth may be temporary.

Concerns about the US economy were exacerbated when new data from a survey of businesses by the US Department of Labour showed that first-time unemployment claims reached 474,000 in April, 10% higher than in March and the highest level in eight months, says QNB Capital. A separate survey of households showed that unemployment had also risen to 9% in April from 8.8% in March.

WeakUS data and wider concern about the state of the global economy, particularly worries about measures undertaken by China to lower inflation, helped to trigger a massive sell-off in commodities prices in the first week of May. The price of Brent, an international benchmark for crude oil prices, fell US$12 to US$109 on 5th May, its largest ever daily fall in nominal terms. Commodities prices dropped across the board, particularly silver, which fell 13% per troy ounce on 5th May to below US$35. This was a drop of over 30% from its all-time high of close to US$50 per troy ounce the previous week. 

The dollar tends to be inversely correlated to the value of commodities in the short term, particularly oil. High inflation in the US economy tends to lead to higher prices of dollar-denominated commodities. Investors, therefore, invest in commodities as a hedge against higher inflation. Expectations of rising inflation also lead to a depreciation of the dollar as inflation undermines the real purchasing value of a unit of currency. The reverse is also true.

Therefore, before the recent negative indicators out of the US, commodities had reached recent highs and the dollar recent lows. Subsequently, weak indicators from the US lowered expectations for US inflation. This, combined with a poorer outlook for the global economy, led to a major divestment out of commodities markets and a rapid appreciation of the dollar. The appreciation of the dollar was compounded by signals from the ECB that its next interest rate increase would be unlikely to come before July. This made the dollar more attractive to investors relative to the euro, as markets had expected higher euro interest rates.