Crashing Commodities Point to a Recession

Demand destruction and the growing threat of recession crushed commodities in Q2. The Fed succeeded in slamming on the breaks, but did they go too far?

Key Takeaways:

Gold dropped to a 9-month low as investors continue their rush to cash.
Copper prices entered a bear market – a key economic signal that has preceded every recession over the last 30 years.
The broad commodities sell-off and a strong dollar are weighing on gold, but both forces have limited lifespans.

Commodities Get Crushed

Gold had a tough quarter, along with most other commodities. Oil, corn, wheat, copper, aluminum, silver, and lumber all got crushed in the second quarter of 2022. Falling commodity prices may release some pressure on inflation, but may also signal something worse: a recession.

Crude oil prices are off 24% from their peak in March. U.S. oil dropped below $100 per barrel, pushing gas prices down slightly.

After rising 40% in the first few months of the year, corn prices have now dropped back to January levels.

Copper prices have plunged 20% since the beginning of June. Other industrial metals, such as iron, aluminum, and nickel, also got crushed this quarter. Copper prices are an important economic bellwether. In fact, according to Zahra Tayeb of Markets Insider, a copper bear market has preceded every recession over the last 30 years. It is difficult to imagine a situation where we avoid a recession this year.

Lumber, one of the most volatile assets since the onset of COVID-19, is down 40% this year. Prices still remain extremely elevated compared to the last 50 years.

Dollar vs. Gold

The dollar currency index just hit a two-decade high. With nowhere else to go, investors continue piling into cash. Because gold is priced in U.S. dollars, a stronger dollar makes gold more expensive for foreign investors.

Ever since Nixon took the dollar off the gold standard, the two assets have been inversely correlated.

The yellow metal is now down 4.8% on the year. Gold does look slightly oversold, which means we could see a small rebound. However, until the dollar stops its upward trend, gold will have limited upside.

While a surging dollar can be a thorn in the side of gold investors, it can also provide amazing opportunities. A high dollar index value can actually serve as a springboard for gold. Over the last 20 years, a dollar index reading of over 103 has always signaled an excellent opportunity to enter the gold market.

The chart below shows the dollar index against gold over the last 30 years. As the green circles indicate, a dollar index above 103 typically correlates with a long-term bottom in the gold price. When the dollar index starts dropping, gold takes off.

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