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The outlook for most physical commodity markets is not optimistic for the coming weeks and perhaps not for the coming months. With the market leading energy complex in a sustained downdraft, it would seem like deflationary forces are set to continue. One might even suggest that sharply lower commodity prices (perhaps even prices sharply below cost of production) might be needed just to provide relief to the economy at large. In the short term, one could suggest that seeing US retail gasoline prices fall all the way down to $1.00 per gallon might alleviate some pressure in the economy, but one has to ask the question just how much benefit will be derived from sharply lower oil prices if businesses and consumers continue fear an unending slowdown ahead. In other words, will consumers turn up their use of energy because of cheaper prices or will that type of result actually require a pick up in economic confidence? On another angle, mortgage rates have started to decline in the wake of a record-shattering and compacted explosion in Treasury futures prices, but the net benefit to the economy as a whole hasn’t reached a significant level yet. For instance, seeing 30 year mortgage rates decline from 6% to 5.5% on a $200,000 mortgage provides only $63 per month in lower mortgage expense. Therefore, while lower rates will help, they haven’t reached a level where they are providing a significant windfall to the economy at large.
30 Year Mortgage Rates

Even though interest rates for other needs are rapidly declining toward extremely low levels, until there is confidence toward business undertakings or more confidence on the jobs front, the amount of fresh borrowing could remain very low. While the Libor and other frozen sectors of the credit markets have steadily improved over the last month and the financial sector seems to be a little more under control, it is also clear that the slowing influence is settling into other sectors of the economy and that the US auto sector was in its “eleventh hour” as of last week. In our opinion the effects of classic slowing look to extend through the month of December and could possibly reach a crescendo into the switchover in political power.

As we have suggested before, the consequences of an environment where falling demand for commodities consistently trumps news of falling commodity supply, we suspect that even lower pricing is ahead. In the long run, the ultimate damage to supply in markets like energies, corn, copper, gold, silver and perhaps sugar could eventually lay the groundwork for explosive price gains down the road, with the main question being how far down the road that will be. However, it is our opinion that the ultimate equilibrium price level in crude oil might be as low as $37 to $40 a barrel, as that is a price level that would effectively remove several more structural sources of energy supply. In the event that oil prices fall to that level and additional production is removed, it could set the stage for a massive explosion in crude oil prices in the face of even a slight improvement in the economic outlook. In the meantime the direction of the energy markets seems to be a major influence of a host of physical commodity prices.

Hydrocarbon Cost of Production

In short, as goes oil, so go the rest of the commodity markets. In conclusion, traders need to look to any remaining historically “expensive” commodities for opportunities on the short side. Markets like soybeans, cocoa, crude oil, sugar and platinum seemingly fit the bill of being expensive! However, given that the downside action in most commodities is increasingly being predicated on further deterioration in the global economy, traders have to be sure to utilize protective strategies against the short side plays because many commodity prices would rebound aggressively in the face of even a slight brightening of the economic skies.

This content originated from – The Hightower Report.