Take a look at this natural gas price chart. Natural gas made its all-time high in 2008 at just above $13 per million British Thermal Units (BTUs). With the advent of natural gas fracking, money had poured in as the price rose, leading to an excess of supply. By September 2009, exacerbated by the financial crisis, the price had collapsed to below $3 per million BTUs. Since then, it has had two bounces to $6, but its nearby future closed Friday at $2.72 on the Nymex, and spot natural gas can be had for less than $1 at the most productive US natural gas field, the Marcellus Shale. At those prices nobody is making money in natural gas. Producer Quicksilver Resources filed for Chapter 11 bankruptcy in March, and much larger Samson Resources has scheduled a bankruptcy filing for September 15.
This is not an analysis of the natural gas market, but rather an explanation of why it’s price graph will be the shape of things to come, not just for natural resources, but for manufacturing and equities. At first, natural gas’s price rose even as a flood of capital was expanding production, precursor to what occurred in oil and other natural resources several years later. In a free market, speculative capital would have been attracted to the possibilities opened up by natural gas fracking. In a world in which central banks have for decades supplied more debt at cheaper interest rates than what would have prevailed in a free market, that flow of capital was amplified. Consequently, so too was the number of natural gas rigs put in operation, the amount of natural gas produced, and the subsequent crash in price. The same can be said for the progressions that came later in oil, iron ore, aluminum, coal, copper, and other extractive industries.
Abnormally cheap, abundant debt does not just distort supply, it distorts demand. The number one distortion is China. It has been on a multi-decade debt binge that has fueled capital spending, manufacturing, production, and an infrastructure build-out. China sucked in raw materials from all over the world, notably Latin America and Australia.
In the US and Europe, government and private debt primarily funded consumption, financial debt went into speculation, and corporations borrowed money to fund share buy backs and dividends. China and oil exporting nations engaged in vendor financing, recycling their trade surpluses into the debt of nations buying their exports. It was a virtuous circle of sorts: production of all manner of natural resources and manufactured goods, amped up by cheap debt, found end markets in countries where consumption had been amped up by cheap debt.
Total world debt increased far faster than the underlying growth rate of the global economy, which meant that assets and income streams became increasingly encumbered by debt claims. It also meant that despite low interest rates, the burden of debt service increased, exerting an ever-heavier drag on the real economy. A broad-based transition from debt expansion to debt contraction first manifested itself in commodities in 2014. The graphs for many natural resources took on the grim aspect of the above natural gas chart after 2008; their prices crashed.
Just as with natural gas, crashing prices impaired and in some cases impaled the ability of indebted producers to service their debts. Credit spreads in the natural resource sector have blown out. Several coal producers and oil fracking companies have gone bankrupt and more will follow. Contraction and financial stress are moving up the production chain. There are already gluts in steel and autos, and the bulk of growth registered in US GDP in the first and second quarters has been due to inventories building. Production cutbacks and layoffs are coming, followed by reductions in consumption by the newly unemployed and further cutbacks and layoffs.
Take another look at the natural gas chart. It’s been over seven years since the price topped out, and it is still only about 20 percent of what it was then. In the bad old days of something closer to dog-eat-dog free market capitalism, downturns were vicious, but they were comparatively short. Gluts in raw materials and crops, intermediate and finished goods, and employment were fixed by falling prices and wages, liquidation and bankruptcy, and newly cheap assets moving from the weak and indebted to the strong and solvent. The depression of 1920-1921 is the most recent example. It was brutal, but it was also over in less than two years (see The Forgotten Depression: 1921: The Crash That Cured Itself, James Grant, Simon and Schuster, 2014) as the government and the Federal Reserve sat on their hands. (The Fed actually raised rates!)
In today’s no-pain-allowed environment, it took seven years before two natural gas producers even went bankrupt. The chart illustrates the harm from the Fed’s ultra-low interest rates, now in their 80th month. They have been perpetual life support for terminally-ill companies for whom the machines should have been turned off long ago.
If you’re looking for when natural gas and other commodities might “recover” and regain their former highs, consider the Japanese stock market. Way back on December 29,1989, the Nikkei 225 made its all-time intra-day high at 38,957.44 and dropped for almost 20 years, 81.9 percent to 7054.98 on March 10, 2009. After rallying strongly the last two years, the Nikkei closed Friday at 19,136.32, which means that it still has to rally over 100 percent to regain its 26-year-old high. Nobody has gone in for government indebtedness, central bank monetization of assets (the Bank of Japan now buys equity ETFs as well as most of the government’s debt), and keeping zombie companies alive as long and with as much fervor as the Japanese, but nobody would argue that these nostrums have done anything but prolong the pain.
With governments’ and central banks’ “help,” the prices of natural gas, other natural resources, goods, and labor may remain depressed for years to come. As the greatest debt bubble in history unwinds, attempts will continue to forestall or prevent markets from making their painful, but necessary adjustments, However, gravity can only be fought for so long. With contraction and falling prices becoming the order of the day in the real economy, it takes a triumph of hope over experience to think financial assets will be immune. Bid farewell to the S&P’s all-time intraday high of 2134.72 on May 20, 2015. It may be a long, long time before the index sees that level again.
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