Commodities are re-entering a 'deflationary vortex'

The pain is far from over for commodity prices.

Gold, crude oil, copper, and aluminium have all had ugly plunges this year, especially in July.

And as far as analysts at Macquarie see it, it’s only going to get worse.

In a note to clients on Monday, the firm writes that the plunge in prices is not just a story of oversupply in commodities but also an undersupply of the dollar.

And so as dollars become more scarce, the dollar gets more expensive, meaning that on a gross basis, fewer dollars buy more commodities, making it hard for the commodities market to clear excess supply.

And with these two things in motion, commodities are about to be sucked into a vortex.

Here’s Macquarie (emphasis added):

The self-reinforcing cycle of higher US$ and lower commodity prices fuels rising deflationary expectations. In conventional cycles of build-up and clearance of capacity as well as decline and rise in demand, low supply of US$ and lower commodities reignite demand and re-balance the global economy. In current climate of secular stagnation, demand does not accelerate whilst overcapacity does not close and investment stagnates.

As a result, inflationary expectations are (again) starting to recede and the break-even rates are gradually returning back to levels that prevailed in deflationary scare of early ’15. In essence, the strong deflationary vortex that dictated investment returns between Jun ’14 and Mar ’15 (replaced by mild inflationary vortex in Mar ’15 – Jul ’15) seems to be returning.

The analysts wrote that with the Federal Reserve getting ready to raise interest rates, the dollar is going to continue to surge even higher.

And with that, there’s no rebound in prices on the horizon.

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