Rising Commodity Prices: Review, Prospect and Retrospect

Commodity prices that have always been the victims of the vagaries of the boom-bust cycle are experiencing the longest rally in the current decade.  The prices of both minerals and food commodities have risen simultaneously after a dip due to the global financial crisis. The quick recovery of the world economy after the global financial crises witnessed even faster increases in the prices of commodities that were accompanied by an unprecedented rise in the last six months. The increase in prices was due to a combination of higher demand and with growing supply not matching the increase in demand. The global economy is now experiencing the longest period of boom in commodity prices. This boom is also the result in part of a supply side shock and structural changes in the world economy.
This article looks at the current price trends and the prospects for the future.

Rajendra Rampersaud

The world economy last witnessed a period of sustained and buoyant price boom in the 1970’s against the backdrop of high global growth and low interest rate. Today that role in global growth is being fuelled by emerging market economies and developing countries. Unlike the past, when rallies in commodity prices had been confined to a select few commodities over the current  period prices have risen for most raw materials  after being busted for a short period during the global financial crisis. Commodity prices have risen at an annual average of 20 percent over the 2004-2007 after a short period of downturn in late 2008; early 2009 saw prices escalating once again on average by 30 percent in the last six months for both minerals and food. The IMF indices of the primary commodity price index show an increase of 181.6 for the period 2000-2010.

The food category experienced substantial increases in the last six months especially for the price of cereals. Wheat prices moved from US$177.5 to US$326.5 an increase of 84.4% percent. The price of maize increased by US$107.2 to US$265.3 while the price of rice the other main cereal increased by 10.6% percent from US$477 to US$527.5. The prices of meat also saw significant increase in the last six months with the price of beef increasing by 30 cents per lb to 185.6 cents, However, the prices of sea food mainly fish and shrimp were more or less flat. Sugar experienced its highest price in the world market rising to almost 34 cents per lb while the US market was even higher, almost 40 cents per lb. However, the price in the European Union was a very low 26.2 cents per lb at the end of January 2011.

The higher and rising prices in agricultural output were mirrored by similar pattern in metals and energy. The price of aluminum increased from US$2096 per Metric tonne to US$2440, an increase of 16.4% percent. The copper price rose by 20% from US$2,024 to US$2439.

The price of gold witnessed the most remarkable increase to US$1,384 per oz; the steady rise in the price of gold was buoyed by the global financial crisis and a weak US dollar as flights to a safe haven investment. The price of oil increased by 17.9% percent from US$78 per barrel to US$92.3 being the average weighted price of UK Brent, Dubai and West Texas Intermediate prices.

The commodities prices increases have been driven by a confluence of factors that influence both the supply and demand side of the equation. The surplus stocks were utilized for both food and industries as inventories were run down to hedge against the higher prices. The sugar stock is now at its lowest since the 1970’s. The low stock levels were further aggravated by supply shock and extreme weather patterns. Australia a member of the CAIRNS group of large food exporting countries experienced heavy flooding that destroyed major crops. Russia a large consumer and producer of wheat was experiencing the worst drought in the century and has halted the exports of wheat to satisfy domestic demand.

The weather pattern also had a negative impact on the output of minerals in 2010. This put pressure on higher demand from industries in Emerging Market and Newly Industrialized Countries.

The improved economic performances of emerging market and developing countries especially the rising middle class in Emerging Economies has led to increased demand for food. Improvements in the standard of living in India and China were followed by increased demand for food especially meat. In 1985, a Chinese consumer ate 20kg (44 lb) of meat a year now he eats more than 50kg. There has been an increase in global demand for cereal especially wheat and rice. The demand for food was further compounded by the demand for animal food such as maize (corn) and soybean for beef, pigs and the poultry sub sector.

Sugar prices hit a 30 years high with sugar production unable to replenish the world stock level that is at an all time low. Brazil did not have a good crop last year putting further pressure on the demand for sugar. The US due to a combination of trade and health factors has been cutting back on the production of the High fructose corn syrup or artificial sweeteners that led to a shortfall of almost 30 percent in the sweetener market. In the retail market in many parts of the world, consumers now faces a price of US$1,000 tones for sugar with consumption and prices growing.

In this article, gold is treated separately since the gold standard has returned to the ‘Midas Touch’ era.

The price of gold rose to its highest level reaching US$1384 per troy ounce with the pundits predicting far higher prices in the future. The rise in the price of gold is very much due to the fact that central banks today trust Gold more as a store of value than fiat currency.

Further, the Exchange Traded Funds (ETF) now purchase gold as a share of their stock which  now exceed 2000 tonnes and are expected to be the third largest holder of gold stock by 2012.

China also purchased 240 tonnes of gold followed by other Emerging Market Economies and oil exporting countries that are accumulating a larger share of their reserves in gold. When the US dollar outpaced the Pound Sterling as a global currency it was the Fed investment in gold that made it possible with an accumulation that was six times larger than Britain. Today China’s Renminbi can become a global currency with it large stock of gold reserves. The Chinese Central Bank is rebalancing its portfolio away from the world major currencies.

In the past, central banks held gold for two main reasons, firstly, as a monetary asset since the value of gold played the role as a nominal anchor for domestic currency and secondly as a war chest as many governments held gold as a means of security in times of international crises. The fluctuating fortunes of fiat money have increased the role of commodity money as a hedge against unforeseen risk and a more reliable store of value.

Unfortunately, the standard text book relationship between demand and price is unable to predict the future of prices with certainty. Models are still unable to grasp the complexities of the real world. Further, the difficulties in modeling static relationships in a dynamic world have led to a perpetual disequilibrium inherited with difficulties in measuring real consumption. However, the trend analysis has provided useful information on the direction of prices.

The turn of the twenty-first century saw a persistent rise of commodity prices after nearly two decades of volatility and bust. Prices rose persistently in the twenty-first century until the global financial crises in 2008 led to a short downturn. However, prices start rising late 2009, reaching new heights by the end of 2010.

This has been the longest period of boom for commodity prices. This boom is driven by greater structural changes in the global economy, lower real currency appreciation, stronger fiscal position and productivity growth in emerging markets and developing countries.

Further the current epoch has seen a rise in south- south trade and as a result developing countries are better able to withstand the fluctuating trend of the business cycle in industrialized countries.

The momentum in Emerging Markets and Newly Industrialized countries is expected to be sustained in the medium term and that should keep the prices of commodities high.