Economist and money manager Gary Shilling has a message for all those investors who think now is a good time to buy oil or other commodities that have plummeted in price over the past year: Don't do it.
"Supplies of almost every commodity are huge and growing," writes Shilling in his latest Insight report. At the same time, demand is falling due to the slowing global economy, says Shilling, president of A. Gary Shilling & Co.
"The Eurozone is limping along at a 1.5% annual growth rate … economic growth in China is slowing … [and] U.S. real GDP has risen at just a 2.2% annual rate since the business recovery began in mid-2009 — about half the rate you'd expect after the most severe recession since the 1930s."
Usually production falls after a big drop in commodity prices, reducing supplies to meet the lower demand, resulting in an equilibrium price. But that hasn't happened in the current commodities market, according to Shilling.
In the oil market, neither OPEC nor Russia has cut production to bring it more in line with demand. Even in the U.S., where several frackers have gone out of business, production is down just 4%, says Shilling.
Oil prices haven't fallen to the "chicken-out point" where producers will slash output because they're losing too much money, says Shilling. That price point is tied to the marginal cost of production, which is close to $40 a barrel for fracking in the U.S. but only between $10 and $20 per barrel in the Persian Gulf and the Permian Basin in Texas, according to Shilling.
A similar game of chicken is being played out in the industrial metals market. "The world's biggest iron ore producers — Rio Tinto (RIO), BHP Billiton (BHP) and Vale (VALE) — continue to produce huge quantities of ore even as prices dropped 70% [from February 2011] to $55 currently because they believe they can squeeze out less-efficient producers with less staying power," writes Shilling.
The slowdown in China is a key factor for the decline in commodity prices worldwide, and that, in turn, is being driven in large part by the slow growth in Europe and North America — both big importers of Chinese products.
