Charles Schwab: How commodity prices affect the wider market

Kully Samra

17 Jul 2013
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Charles Schwab: How commodity prices affect the wider market

The wake from commodity prices shakes many sectors

There is no official category labelled ‘commodities’ within the S&P’s list of ten economic sectors, but commodities are incredibly important to the market.

Commodities have the potential to influence almost every industry to some degree, and therefore investors who look to move tactically among the various groupings should have at least a working understanding of commodities and a view as to what their general direction may be.

The ways that commodity prices can influence companies are too numerous to list in the limited space we have here, so we will focus on the two sectors that have the potential to feel a greater impact than others.

Obviously the energy sector relies heavily on the price of oil, but the first group we are going to look at is materials, which can be exposed to many different commodities, from energy-related ones to metals.

Typically, stronger commodity prices benefit the materials group as they indicate increased demand for the goods that the sector provides, which provides more pricing power and the potential to expand margins.

As we are now seeing accommodative monetary policy around most of the globe, the materials sector has been affected positively with growth expectations increasing. This is largely why the materials group is considered cyclical: demand for commodities tends to increase as the US economy grows.

Conversely, although it also benefits from improved economic conditions, the consumer discretionary sector will typically benefit from lower commodity prices, especially energy and food-related costs.

We have seen consumers reduce their debt load, housing strengthen, and auto sales improve, which indicates better consumer confidence, and the job market appears to be accelerating at least slightly. Lower expenditure on these items leaves more in consumers' pockets to spend on discretionary items.

Now, this doesn't necessarily mean that both the materials sector and the discretionary sector could both outperform at the same time as there are many factors involved in sector performance, but consideration should be given to whether these other factors outweigh the commodity impact.

Currently, we believe that the commodity so-called supercycle, which involved steadily rising prices for an extended period, has come to an end and that we are in for some largely sideways movement in the majority of the commodity complex.

New supply due to improved technology and more players in the market, combined with slowing demand growth due to a seemingly maturing Chinese economy and more efficient uses of commodities, contribute to our belief.

But given the potential importance of the direction of commodities to sector performance, and we've only scratched the surface in this piece, we continue to track developments closely.

Related topics: Commodities

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