The recent, "It's official; we're in a recession" announcement on Monday comes as no surprise to most people, and definitely not to anyone investing in the commodity markets. It just means that we can "officially" use the word everyone has been whispering in the back room.

Commodities investors took the hit on the demand side early in this recession, but it seems like only recently that the realization has come on in full force. On November 11, the AP ran this quote from Richard Feltes, senior vice president and director of commodity research for MF Global in Chicago, which summed it up nicely: "Commodities and equities, which are typically inversely proportional, seem to be trading in lockstep. Commodity demand is tied to economic growth, and to the extent that the equity markets are signaling continued economic slowdown, that means lower demand for basic commodity materials, be it steel or grains or whatever."

So far, the commodities crash has been the story of demand drying up. As we point out here again and again, commodities are the home of microeconomic purity, where supply and demand come home to roost.

But an interesting thing has been happening recently, which has major implications for the commodities market in the future: Supply is starting to dry up as well.

The canary in the coal mine for this is the Baltic Dry Shipping Index, which is trading at record lows. Large bulk carriers are reportedly available for hire for literally less than the cost of the suite at The Ritz.

The ship prices are absurd. It now costs just $2,800 a night to rent a bulk carrier, down from $250,000+ just six months ago.

Let's be realistic; there aren't really a lot of ships running around the Pacific at those rates. Those rates are symptomatic of a complete collapse in that corner of the market, with huge numbers of carriers sitting idle.

And the reason the prices are so low in the first place is that mining companies are slowing down production, even closing mines, as fast as they can.

What Does It Mean?

It's perhaps blasphemous to suggest that the market is acting in a fairly rational way. Demand has fallen, and we're finally seeing supply contract as a result. Ultimately, this means prices will stabilize for what we suspect is a depressed level of demand, which primes them to go higher in a hurry when demand resumes. And this could happen in a significant way.

Iron & Steel

Nowhere is the supply crunch more evident than in the big bad industrial sector - the one made out of steel and stone.

The biggest headline, after years of watching, is that BHP finally called off its hunt of Rio Tinto. Citing the global downturn, low commodity prices and tight credit markets, BHP just let the deal evaporate.

But cancelling deals isn't the only thing BHP has been doing ... or not doing. In the latter part of November, they announced iron pellet production cuts in Brazil, and on Tuesday this week, they announced temporary cuts in manganese production because of weak market conditions. While not a tradable metal, this minor metal is strategic - in other words, another canary - in making steel, batteries and items like aluminum cans. (For a discussion of minor metals and their strategic role, check out HAI's interview with Charles Swindon from this past June.)

BHP is not the only company that is cutting back. U.S. Steel just announced yesterday that they will be idling three of their steel mills - but for how long, no one is saying. "The length of the layoffs depends on the strengthening of customer demand," Erin DiPietro, a spokesperson for U.S. Steel, was reported as saying.

In other words, don't hold your breath.

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