Expect a Prolonged Slump in Commodity ETFs | ETF Trends

Commodities exchange traded funds could be stuck in an extended downtrend as a so called negative feedback loop of increased production and high liquidity keep pressure on prices.

The broad commodities market has been trending lower. Year-to-date, the GreenHaven Continuous Commodity Index Fund (NYSEArca: GCC) dipped 6.7%, PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC) fell 7.5%, iPath Dow Jones-UBS Commodity Index Total Return ETN (NYSEArca: DJP) declined 7.4% and iShares GSCI Commodity-Indexed Trust (NYSEArca: GSG) dropped 8.3%.

“Commodity markets still have access to far too much capital relative to future demand and a declining cost structure,” according to Goldman Sachs analysts, reports  Ben Sharples for Bloomberg.  “Long-term surpluses in most commodity markets require prices to remain lower for longer to balance both the near-term physical supply and demand, but more importantly, the longer-term supply and demand for capital to fund future investments.”

Goldman believes the commodities market may be stuck in a “negative feedback loop” where lower prices are bolstering the U.S. dollar and lowering production costs for countries with depreciating currencies. The bank argues that it raises the prospects of higher interest rates and reduction in emerging market debt, which could also lead to lower commodities demand, lower resource prices and further strengthening the greenback.

To get out of this cycle, commodity prices would have to plunge to a point where it forces low-cost producers to cut supply. Consequently, Goldman projects that the commodity slump could last five to 10 years before any meaningful changes are made.