In recent years, emerging countries have been marked by a triple whammy of deflation, divergence, and deleveraging. Falling commodity prices have contributed to increased deflationary pressures on emerging economies. The divergence between the slowdown in activity and the recovery of the US economy has led to an appreciation of the US dollar, resulting in higher financing costs for emerging countries, some of whose external debt is denominated in dollars. This has led companies to deleverage, resulting in lower investment and weaker demand for commodities.
In early 2016, the 3Rs replaced the 3Ds: Reflation – Realignment – Releveraging. The recovery in commodity prices (reflation), fears of recession in the United States led to less divergence between economies (realignment) and a strong recovery in credit in China (releveraging).
This transition from the 3Ds to the 3Rs does not appear to be sustainable, as it would require commodity prices to remain high. (1) The decline in oil production is not sufficient to have a lasting impact on prices. (2) Inventories in the United States remain at very high levels. (3) The more than 30% rise in the price of Brent crude in recent weeks appears to be driven more by a decline in supply than by an increase in demand. However, as supply is not lower than demand, further upward pressure seems unlikely. (4) Chinese growth continues to be supported by excess credit, which increased in January. To encourage the transition to greater private consumption, the Chinese government is seeking to reduce the stock of available real estate by easing financial conditions, which would fuel a rise in real estate prices, generating a wealth effect and thus consumer confidence. However, Chinese demand for raw materials has not increased significantly or sustainably.
This transition from 3Ds to 3Rs does not seem any more sustainable if we look at the macroeconomic fundamentals. The divergence with the United States persists: the US labor market is performing well, real estate prices are rising steadily, consumption is supporting activity, and inflation has already reached the Fed’s year-end target. Only a slowdown in the manufacturing sector could support the argument for less divergence. The current uncertainty should correct itself and contain upward pressure on the price of gold. There is indeed reflation in commodity prices, but no realignment is observed.
