While gold garnered most of the headlines last year (down 27%), commodities performed badly across the board in 2013. We expect more of the same in 2014. We’d continue avoiding commodity-oriented equity groups as well—unless their rankings make a sudden U-turn. Gold’s continued weakness is important because it tends to move in advance of the rest of the commodity complex (Chart 1). The huge year-over-year decline in gold portends—at a minimum—a weak first half for industrial commodities.
As they have for the past two years, commodity bulls continue banking on a reacceleration in Emerging Markets demand for raw materials. If such an acceleration were imminent, one would think the MSCI BRIC Index would be the first to sniff it out. Yet that index remains among the poorest performing market composites in the world.
Commodity demand will eventually right itself, though. Our worry, as we’ve detailed for more than two years, is supply. Chart 2 shows that players in the global Energy and Materials sectors waited right up until the final “Act” of last decade’s Three Act commodity play to embark on a massive spending binge. Capital spending levels (shown here in relation to depreciation) remain elevated, and are far above the levels seen just over a decade ago—on the eve of China’s great commercial and residential construction boom. Commodity producers didn’t anticipate that boom, which is precisely why it was so powerful. More than a decade later, we think they’ve underestimated the extent to which EM growth is set to diversify away from the construction and investment-led model, which is precisely why the bust should continue.
After 12 consecutive up years for gold from 2001 to 2012, we wouldn’t be surprised to see it suffer another big drop in 2014. Gold could drop all the way to $700/oz. without violating its long-term secular uptrend, according to some of our analysis. While we don’t have a strong secular viewpoint on gold currently, our best guess is that gold closes 2014 at $900—another decline of 25%.
© Leuthold Weeden Capital Management