Why commodities trading is cooling off

Will Hodges explains the downturn in the goods and materials markets

Commodities - industrial materials and agricultural goods bought and sold on a large scale - are one of the most traded sets of assets on the financial markets.

However, increased regulation of commodities markets in recent years, coupled with falling profits, has seen a number of businesses operating in this sector looking to scale back.

In March this year, US investment bank J.P. Morgan offloaded its physical commodities unit to Mercuria Energy Group Ltd. for $3.5 billion (£2.1 billion) following pressure from US regulators.

More recently, Barclays has revealed that it will dissolve its commodities trading business, placing 160 jobs at risk.

The China effect

Increased regulation is a new unwanted hurdle for many commodities traders and many firms are also feeling the pressure of increased competition within the sector.

Massive expansion of emerging market economies during the 2000s led to a huge surge in demand for raw materials such as metals and crude oil.

China in particular became a voracious consumer of metals commodities such as copper, iron ore and bauxite that were needed to support the development of new towns and infrastructure, while increased imports of coal, gas and oil were needed to keep its factories running.

This led to huge upswings in the price of many commodities, which in turn whetted the appetites of financial investors the world over.

To satisfy this demand, a number of financial firms opened new dedicated commodities trading arms, while a number of smaller specialist traders also set up shop to take advantage of a growing market.

Boom and bust

However, with China's juggernaut growth starting to slow in recent months, demand for and the price of commodities has followed suit.

"The commodity boom years of the 2000-2011 period are behind us," says John Davies, head of commodities research at Business Monitor International.

"As Chinese economic growth continues to cool, commodity prices will increasingly begin to reflect their true prices rather than the inflated values of the past few years."

During the first quarter of 2014, the Chinese economy grew by 7.4 per cent. While still well above the level enjoyed by most western states, the rate of growth is far below the 10 per cent plus expansion seen in recent years and was below the government's target of 7.5 per cent.

This slowdown in China, which has led to fewer imports of raw materials, has had an immediate bearing on global commodities prices.

At the start of 2013, the value of the global index for all commodities was 15 per cent lower than it had been at its peak during summer 2008.

So with the market losing much of its appeal for a number of linked reasons, it's not surprising that Barclays, J.P. Morgan and others are cutting back this relatively small arm of their overall businesses before they start to incur major losses.