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Do U.S. Tariffs Change Our Commodity Outlook?

Wells Fargo Investment Institute - 3/12/18

Key takeaways

  • The U.S. recently imposed tariffs on imported steel and aluminum. The U.S. also imposed steel tariffs in 2002, which led to higher domestic steel prices.
  • Over the long term, it is exceedingly difficult for one country to influence global commodity prices. Other factors, such as the commodity price super-cycles, often are more dominant.

What it may mean for investors

  • Steel and aluminum prices may have room to move higher in the short term. However, these rallies should be contained by the overall dampening effect of the commodity bear super-cycle, which we expect to last for at least another five years. The tariffs have not altered our broad commodity outlook. We remain bearish in the short term and neutral-to-bearish in the long term.

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“Nothing is more obstinate than a fashionable consensus.” - Margaret Thatcher

Do U.S. Tariffs Change Our Commodity Outlook?

The short answer is no. Tariffs on steel and aluminum imports are not enough to change our short-term or long-term views on the commodity complex.

Our 2018 commodity view (short term): Bearish

Steel and aluminum make up a fraction of the overall commodity complex. Most major commodity indices, such as the Bloomberg Commodity Index (BCOM), have very slight weightings in industrial metals. Energy is most often the dominant sector inside commodity indices, followed by agriculture, then precious metals. For the remainder of 2018, we are expecting commodity weakness, driven largely by energy-related commodities, such as oil. Our target for West Texas Intermediate (WTI) oil prices is between $50 and $60 (with the midpoint being $55).  

With that said, we expect steel and aluminum prices to rise in 2018, and possibly into 2019. The last time that the U.S. imposed tariffs in the steel industry was in 2002, and the U.S. did see higher domestic steel prices. The effect was steel-price spikes in 2002 and 2003, and falling U.S. steel imports. 

Chart 1 shows steel prices on a year-to-year basis. Notice the price spike, which began in 2002, and continued until 2008. Now, to be clear, steel prices did not consistently rise from 2002 through 2008 only because of a U.S. tariff. Most commodities started rising during that period, thanks to a new commodity bull super-cycle, which we begin explaining with Chart 2.

Chart 1. Producer Price Index for iron and steel (year-over-year % change)

Chart 1. Producer Price Index for iron and steel (year-over-year % change)

Sources: Bloomberg, Bureau of Labor Statistics (BLS), Wells Fargo Investment Institute. Yearly data: December 31, 1982 - December 31, 2017. The Producer Price Index (PPI) is a family of indexes that measures the average change over time in selling prices received by domestic producers of goods and services. PPIs measure price change from the perspective of the seller.

Chart 2 highlights industrial metals prices over the past 20 years. Notice that these prices generally tend to move together (and specifically to our point today, did so during the 2000s). It is true that the U.S. instituted a tariff on steel imports in 2002 and 2003, which likely had some impact on steel prices. How much impact that change had on prices is hard to discern, however, as most industrial commodity (and most other commodity) prices were rising.

Chart 2. Steel versus copper and aluminum

Chart 2. Steel versus copper and aluminum

Sources: Bloomberg, Bureau of Labor Statistics, Wells Fargo Investment Institute. Monthly data: January 31, 1998 - January 31, 2018. 

Commodity view beyond 2018 (long term): Bearish/neutral

Commodities are global in nature—as they are produced and consumed by many different countries. The U.S. is a large consumer of commodities and commodity-related products, so the U.S. market impact cannot be dismissed in the short term. Over the long term, however, history suggests that it is exceedingly difficult for one country to influence global commodity prices. Other factors often are more dominant, such as the commodity price super-cycles that we like to discuss.  

Commodity prices move together over long periods of time, which we call super-cycles. The average bull market super-cycle has lasted roughly 16 years; the average bear about 20 years. The last bull market for commodity prices ran for roughly 12 years, from 1999 through 2011. These statistics can be found in the two tables shown with Chart 3. The shaded areas in Chart 3 represent the commodity bear super-cycles, while the white areas cover the bull super-cycles. An important note is that most commodity prices generally move up together, and down together, over these long cycles.

Chart 3. Commodity bear market super-cycles

Chart 3. Commodity bear market super-cycles

Sources: Bloomberg, Prices by G.F. Warren and F.A. Pearson, Bureau of Labor Statistics (BLS), Bureau of Economic Research (NBER), Wells Fargo Investment Institute. Monthly Data: 1/31/1800 - 2/28/2018. The Commodity Composite measures a basket of commodity prices as well as inflation. It blends the historical commodity composite from George F. Warren and Frank A. Pearson; the U.S. Bureau of Labor Statistics Producer Price Index for Commodities; the National Bureau of Economic Research Index of Wholesale Prices of 15 Commodities; and the Thomson Reuters Equal Weight Commodity Index. An index is unmanaged and not available for direct investment.  Past performance is no guarantee of future results.

Some of you may be thinking that not all commodities follow one another. As the logic goes, we do not consume wheat like we do oil, or silver. Over the short term, this is the case. As an example, we consume oil throughout a year differently than we consume wheat. However, over the long run, commodity prices generally follow one another regardless of consumption patterns. Chart 4 showcases three different commodities, which are consumed year-to-year quite differently. Notice, though, that their prices generally track one another, and the rest of the commodity complex (green line), over the long term. 

Chart 4. Oil, wheat, and silver versus commodities (1914 – present)

Chart 4. Oil, wheat, and silver versus commodities (1914 – present)

Sources: Bloomberg, Kitco, U.S. Department of Agriculture (USDA), Prices by Warren and Pearson, BLS, NBER, FRED, Wells Fargo Investment Institute. Monthly data: 1/31/1914 - 2/28/2018. Values shown in log scale.  Indexed to 100 as of 1/31/1914.

It is evident from Chart 3 that commodity bull super-cycles almost always end badly. It is not a coincidence that most commodity prices crashed between 2011 and 2014. It started with copper and industrial metals in 2010, bled into precious metals in 2011, moved to food commodities in 2012, and eventually hit oil in 2014. The crash occurs because prices tend to rise too far, too fast, which invites lots of competition and substitution. When thinking of “too far too fast,” you can think of oil prices for the 10 year period from 1998 to 2008—prices rose more than fifteen-fold, from roughly $10 to $150 per barrel. Competition and substitution bring with them excess supply, which swamps commodity prices. And, unfortunately for commodity bulls, excess supply is not something that corrects itself overnight. As we stated earlier, the average commodity bear super-cycle has lasted nearly 20 years, with the shortest being 12 years.

As of 2018, we believe that we are seven years into the current commodity bear super-cycle—as most commodity markets remain swamped in excess supply. We are expecting at least another five years of the same trend. For most commodity prices, this means lots of range-bound price action and capped rallies. For steel and aluminum specifically, there may be room for these commodity prices to move higher in the next few years, but if the history of commodity super-cycles is a good guide, even these rallies should be contained. The bottom line is that our commodity views, both in the short and long term, have not changed with recent U.S. tariff talk. We remain bearish in the short term and neutral/bearish in the long term on the commodity complex.