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Posts Tagged ‘commodity prices’

Future for the global economy

There is a lot of pessimism around about the state of the global economy and the prospects for more sustained growth. Stock markets have been turbulent; oil and other commodity prices have fallen; inflation has been below central bank targets in most countries; and growth has declined in many countries, most worryingly in China.

The latest worry, expressed by finance ministers at the G20 conference in Shanghai, is that UK exit from the EU could have a negative impact on economic growth, not just for the UK, but for the global economy generally.

But is this pessimism justified? In an interesting article in the Independent, Hamish McRae argues that there are five signs that the world economy is not doomed yet! These are:

There are more monetary and fiscal measures that can still be taken to boost aggregate demand.
Despite some slowing of economic growth, there is no sign of a global recession in the offing.
US and UK growth are relatively buoyant, with consumer demand ‘driving the economy forward’.
Deflation worries are too great, especially when lower prices are caused by lower commodity prices. These lower costs should act to stimulate demand as consumers have more real purchasing power.
Inflation may start to edge upwards over the coming months and this will help to increase confidence as it will be taken as a sign that demand is recovering.

So, according to McRae, there are five things we should look for to check on whether the global economy is recovering. He itemises these at the end of the article. But are these the only things we should look for?

Five signs that the world economy is not doomed yet Independent, Hamish McRae (27/2/15)

Questions

  1. What reasons are there to think that the world will grow more strongly in 2016 than in 2015?
  2. What reasons are there to think that the world will grow less strongly in 2016 than in 2015?
  3. Distinguish between leading and lagging indicators of economic growth.
  4. Do you agree with McRae’s choice of five indicators of whether the world economy is likely to grow more strongly?
  5. What indicators would you add to his list?
  6. Give some examples of ‘economic shocks’ that could upset predictions of economic growth rates. Explain their effect.
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What would Keynes say?

Here are two thought-provoking articles from The Guardian. They look at macroeconomic policy failures and at the likely consequences.

In first article, Larry Elliott, the Guardian’s Economics Editor, argues that Keynesian expansionary fiscal and monetary policy by the USA has allowed it to achieve much more rapid recovery than Europe, which, by contrast, has chosen to follow fiscal austerity policies and only recently mildly expansionary monetary policy through a belated QE programme.

In the UK, the recovery has been more significant than in the eurozone because of the expansionary monetary policies pursued by the Bank of England in its quantitative easing programme. ‘And when it came to fiscal policy, George Osborne quietly abandoned his original deficit reduction targets when the deleterious impact of an over-aggressive austerity strategy became apparent.’

So, according to Larry Elliott, Europe should ease up on austerity and governments should invest more though increased borrowing.

‘This is textbook Keynesian stuff. Unemployment is high, which means businesses are reluctant to invest. The lack of investment means that demand for new loans is weak. The weakness of demand for loans means that driving down the cost of borrowing through QE will have little impact. Therefore, it is up to the state to break into the vicious circle by investing itself, something it can do cheaply and – because there are so many people unemployed and businesses working well below full capacity – without the risk of inflation.’

In the second article, Paul Mason, the Economics Editor at Channel 4 News, points to the large increases in both public- and private- sector debt since 2007, despite the recession. Such debt, he argues, is becoming unsustainable and hence the world could be on the cusp of another crash.

Mason quotes from the Bank for International Settlements Quarterly Review September 2015 – media briefing. In this briefing, Claudio Borio,
Head of the Monetary & Economic Department, argues that:

‘Since at least 2009, domestic vulnerabilities have developed in several emerging market economies (EMEs), including some of the largest, and to a lesser extent even in some advanced economies, notably commodity exporters. In particular, these countries have exhibited signs of a build-up of financial imbalances, in the form of outsize credit booms alongside strong increases in asset prices, especially property prices, supported by unusually easy global liquidity conditions. It is the coincidence of the reversal of these booms with external vulnerabilities that should be watched most closely.’

We have already seen a fall in commodity prices, reflecting the underlying lack of demand, and large fluctuations in stock markets. The Chinese economy is slowing markedly, as are several other EMEs, and Europe and Japan are struggling to recover, despite their QE programmes. The USA is no longer engaging in QE and there are growing worries about a US slowdown as growth in the rest of the world slows. Mason, quoting the BIS briefing, states that:

‘In short, as the BIS economists put it, this is “a world in which debt levels are too high, productivity growth too weak and financial risks too threatening”. It’s impossible to extrapolate from all this the date the crash will happen, or the form it will take. All we know is there is a mismatch between rising credit, falling growth, trade and prices, and a febrile financial market, which, at present, keeps switchback riding as money flows from one sector, or geographic region, to another.’

So should there be more expansionary policy, or should rising debt levels be reduced by tighter monetary policy? Read the articles and then consider the questions.

I told you so. Obama right and Europe wrong about way out of Great Recession The Guardian, Larry Elliott (1/11/15)
Apocalypse now: has the next giant financial crash already begun? The Guardian, Paul Mason (1/11/15)

Questions

  1. To what extent do the two articles (a) agree and (b) disagree?
  2. How might a neo-liberal economist reply to the argument that what is needed is more expansionary fiscal and monetary policies?
  3. What is the transmission mechanism whereby quantitative easing affects real output? Is it a reliable mechanism for policymakers?
  4. What would make a financial crash less likely? Is this something that governments or central banks can influence?
  5. Why has productivity growth been so low in many countries? What would increase it?
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What’s the outlook for the global economy?

The International Monetary Fund has just published its six-monthly World Economic Outlook (WEO). The publication assesses the state of the global economy and forecasts economic growth and other indicators over the next few years. So what is this latest edition predicting?

Well, once again the IMF had to adjust its global economic growth forecasts down from those made six months ago, which in turn were lower than those made a year ago. As Larry Elliott comments in the Guardian article linked below:

Every year, economists at the fund predict that recovery is about to move up a gear, and every year they are disappointed. The IMF has over-estimated global growth by one percentage point a year on average for the past four years.

In this latest edition, the IMF is predicting that growth in 2015 will be slightly higher in developed countries than in 2014 (2.0% compared with 1.8%), but will continue to slow for the fifth year in emerging market and developing countries (4.0% in 2015 compared with 4.6% in 2014 and 7.5% in 2010).

In an environment of declining commodity prices, reduced capital flows to emerging markets and pressure on their currencies, and increasing financial market volatility, downside risks to the outlook have risen, particularly for emerging market and developing economies.

So what is the cause of this sluggish growth in developed countries and lower growth in developing countries? Is lower long-term growth the new norm? Or is this a cyclical effect – albeit protracted – with the world economy set to resume its pre-financial-crisis growth rates eventually?

To achieve faster economic growth in the longer term, potential national output must grow more rapidly. This can be achieved by a combination of more rapid technological progress and higher investment in both physical and human capital. But in the short term, aggregate demand must expand sufficiently rapidly. Higher short-term growth will encourage higher investment, which in turn will encourage faster growth in potential national output.

But aggregate demand remains subdued. Many countries are battling to cut budget deficits, and lending to the private sector is being constrained by banks still seeking to repair their balance sheets. Slowing growth in China and other emerging economies is dampening demand for raw materials and this is impacting on primary exporting countries, which are faced with lower exports and lower commodity prices.

Quantitative easing and rock bottom interest rates have helped somewhat to offset these adverse effects on aggregate demand, but as the USA and UK come closer to raising interest rates, so this could dampen global demand further and cause capital to flow from developing countries to the USA in search of higher interest rates. This will put downward pressure on developing countries’ exchange rates, which, while making their exports more competitive, will make it harder for them to finance dollar-denominated debt.

As we have seen, long-term growth depends on growth in potential output, but productivity growth has been slower since the financial crisis. As the Foreword to the report states:

The ongoing experience of slow productivity growth suggests that long-run potential output growth may have fallen broadly across economies. Persistently low investment helps explain limited labour productivity and wage gains, although the joint productivity of all factors of production, not just labour, has also been slow. Low aggregate demand is one factor that discourages investment, as the last World Economic Outlook report showed. Slow expected potential growth itself dampens aggregate demand, further limiting investment, in a vicious circle.

But is this lower growth in potential output entirely the result of lower demand? And will the effect be permanent? Is it a form of hysteresis, with the effect persisting even when the initial causes have disappeared? Or will advances in technology, especially in the fields of robotics, nanotechnology and bioengineering, allow potential growth to resume once confidence returns?

Which brings us back to the short and medium terms. What can be done by governments to stimulate sustained recovery? The IMF proposes a focus on productive infrastructure investment, which will increase both aggregate demand and aggregate supply, and also structural reforms. At the same time, loose monetary policy should continue for some time – certainly as long as the current era of falling commodity prices, low inflation and sluggish growth in demand persists.

Articles
Uncertainty, Complex Forces Weigh on Global Growth IMF Survey Magazine (6/10/15)
A worried IMF is starting to scratch its head The Guardian, Larry Elliott (6/10/15)
Storm clouds gather over global economy as world struggles to shake off crisis The Telegraph, Szu Ping Chan (6/10/15)
Five charts that explain what’s going on in a miserable global economy right now The Telegraph, Mehreen Khan (6/10/15)
IMF warns on worst global growth since financial crisis Financial Times, Chris Giles (6/10/15)
Global economic slowdown in six steps Financial Times, Chris Giles (6/10/15)
IMF Downgrades Global Economic Outlook Again Wall Street Journal, Ian Talley (6/10/15)

WEO publications
World Economic Outlook, October 2015: Adjusting to Lower Commodity Prices IMF (6/10/15)
Global Growth Slows Further, IMF’s latest World Economic Outlook IMF Podcast, Maurice Obstfeld (6/10/15)
Transcript of the World Economic Outlook Press Conference IMF (6/10/15)
World Economic Outlook Database IMF (October 2015 edition)

Questions

  1. Look at the forecasts made in the WEO October editions of 2007, 2010 and 2012 for economic growth two years ahead and compare them with the actual growth experienced. How do you explain the differences?
  2. Why is forecasting even two years ahead fraught with difficulties?
  3. What factors would cause a rise in (a) potential output; (b) potential growth?
  4. What is the relationship between actual and potential economic growth?
  5. Explain what is meant by hysteresis. Why may recessions have a permanent negative effect, not only on trend productivity levels, but on trend productivity growth?
  6. What are the current downside risks to the global economy?
  7. Why have commodity prices fallen? Who gains and who loses from lower commodity prices? Does it matter if falling commodity prices in commodity importing countries result in negative inflation?
  8. To what extent can exchange rate depreciation help commodity exporting countries?
  9. What is meant by the output gap? How have IMF estimates of the size of the output gap changed and what is the implication of this for actual and potential economic growth?
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Deficiency of demand: a global problem

The first link below is to an excellent article by Noriel Roubini, Professor of Economics at New York University’s Stern School of Business. Roubini was one of the few economists to predict the 2008 financial crisis and subsequent recession. In this article he looks at the current problem of substantial deficiency of demand: in other words, where actual output is well below potential output (a negative output gap). It is no wonder, he argues, that in these circumstances central banks around the world are using unconventional monetary policies, such as virtually zero interest rates and quantitative easing (QE).

He analyses the causes of deficiency of demand, citing banks having to repair their balance sheets, governments seeking to reduce their deficits, attempts by firms to cut costs, effects of previous investment in commodity production and rising inequality.

The second link is to an article about the prediction by the eminent fund manager, Crispin Odey, that central banks are running out of options and that the problem of over-supply will lead to a global slump and a stock market crash that will be ‘remembered in a hundred years’. Odey, like Roubini, successfully predicted the 2008 financial crisis. Today he argues that the looming ‘down cycle will cause a great deal of damage, precisely because it will happen despite the efforts of central banks to thwart it.’

I’m sorry to post this pessimistic blog and you can find other forecasters who argue that QE by the ECB will be just what is needed to stimulate economic growth in the eurozone and allow it to follow the USA and the UK into recovery. That’s the trouble with economic forecasting. Forecasts can vary enormously depending on assumptions about variables, such as future policy measures, consumer and business confidence, and political events that themselves are extremely hard to predict.

Will central banks continue to deploy QE if the global economy does falter? Will governments heed the advice of the IMF and others to ease up on deficit reduction and engage in a substantial programme of infrastructure investment? Who knows?

An Unconventional Truth Project Syndicate, Nouriel Roubini (1/2/15)
UK fund manager predicts stock market plunge during next recession The Guardian, Julia Kollewe (30/1/15)

Questions

  1. Explain each of the types of unconventional monetary policy identified by Roubini.
  2. How has a policy of deleveraging by banks affected the impact of quantitative easing on aggregate demand?
  3. Assume you predict that global economic growth will increase over the next two years. What reasons might you give for your prediction?
  4. Why have most commodity prices fallen in recent months? (In the second half of 2014, the IMF all-commodity price index fell by 28%.)
  5. What is likely to be the impact of falling commodity prices on global demand?
  6. Some neo-liberal economists had predicted that central bank policies ‘would lead to hyperinflation, the US dollar’s collapse, sky-high gold prices, and the eventual demise of fiat currencies at the hands of digital krypto-currency counterparts’. Why, according to Roubini, did the ‘root of their error lie in their confusion of cause and effect’?
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Commodity prices fall to four-year low

Commodity prices have been falling for the past three years and have reached a four-year low. Since early 2011, the IMF overall commodity price index (based on 2005 prices) has fallen by 16.5%: from 210.1 in April 2011 to 175.4 in August 2014. The last time it was this low was December 2010.

Some commodity prices have fallen by greater percentages, and in other cases the fall has been only slight. But in the past few months the falls have been more pronounced across most commodities. The chart below illustrates these falls in the case of three commodity groups: (a) food and beverages, (b) agricultural raw materials and (c) metals, ores and minerals. (Click here for a PowerPoint of the chart.)

Commodity prices are determined by demand and supply, and factors on both the demand and supply sides have contributed to the falls.

With growth slowing in China and with zero growth in the eurozone, demand for commodities has shown little growth and in some cases has fallen as stockpiles have been reduced.

On the supply side, investment in mining has boosted the supply of minerals and good harvests in various parts of the world have boosted the supply of many agricultural commodities.

But in historical terms, prices are still relatively high. There was a huge surge in commodity prices in the period up to the financial crisis of 2008 and then another surge as the world economy began to recover from 2009–11. Nevertheless, taking a longer-term perspective still, commodity prices have risen in real terms since the 1960s, but with considerable fluctuations around this trend, reflecting demand and supply at the time.

Articles
Commodities Fall to 5-Year Low With Plenty of Supplies Bloomberg Businessweek, Chanyaporn Chanjaroen (11/9/14)
Commodity ETFs at Multi-Year Lows on Supply Glut ETF Trends, Tom Lydon (11/9/14)
What dropping commodity prices mean CNBC, Art Cashin (11/9/14)
Goldman sees demand hitting commodity price DMM FX (12/9/14)
Commodity price slump is a matter of perspective Sydney Morning Herald, Stephen Cauchi (11/9/14)
Commodities index tumbles to five-year low Financial Times, Neil Hume (12/9/14)
Commodities: More super, less cycle HSBC Global Research, Paul Bloxham (8/1/13)
Commodity prices in the (very) long run The Economist (12/3/13)

Data
IMF Primary Commodity Prices IMF
UNCTADstat UNCTAD (Select: Commodities > Commodity price long-term trends)
Commodity prices Index Mundi

Questions

  1. Identify specific demand-and supply-side factors that have affected prices of (a) grains; (b) meat; (c) metal prices; (d) oil.
  2. Why is the demand for commodities likely to be relatively inelastic with respect to price, at least in the short term? What are the implications of this for price responses to changes in supply?
  3. Why may there currently be a ‘buying opportunity’ for potential commodity purchasers?
  4. What is meant by the ‘futures market’ and future prices? Why may the 6-month future price quoted today not necessarily be the same as the spot price (i.e. the actual price for immediate trading) in 6 months’ time?
  5. How does speculation affect commodity prices?
  6. How does a strong US dollar affect commodity prices (which are expressed in dollars)?
  7. How may changes in stockpiles give an indication of likely changes in commodity prices over the coming months?
  8. Distinguish between real and nominal commodity prices. Which have risen more and why?
  9. How do real commodity prices today compare with those in previous decades?
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Slowing down under

When the rest of the developed world went into recession after the financial crisis of 2007/8, the Australian economy kept growing, albeit at a slightly lower rate (see chart 1: click here for a PowerPoint). Then as the world economy began to grow again after 2009, Australian grow accelerated. Partly this was the result of a strong growth in demand for Australian mineral exports, such as coal, iron ore and bauxite, especially from China and other east Asian countries.

But in 2013, Australian growth slowed and jobs grew by their lowest rate for 17 years. Employment actually fell by 22,600 in December and unemployment was only prevented from rising by a fall in the participation rate. The Australian dollar, which has been depreciating in recent months, fell further on the news about jobs, reaching its lowest level for over two years (see chart 2: click here for a PowerPoint).

      Chart 1

    Chart 2

The following articles look at the reasons behind Australia’s slowing growth and at possible reactions of the Australian government and the Reserve Bank of Australia (Australia’s central bank). They also look at the link between economic performance and policy on the one hand and the exchange rate on the other.

Aussie Hits a 4 Year Low As Jobs Picture Turns Grim FX Street, Boris Schlossberg (16/1/14)
Unemployment rises: Rate cut on the cards? The Motely Fool, Mike King (16/1/14)
Australia posts its lowest annual jobs growth in 17 years The Guardian (16/1/14)
Australian dollar drops to four-year low after unemployment figures released The Guardian (16/1/14)
Unemployment … Coming to a Suburb Near You Pro Bono Australia News (13/1/14)
Jobs disappear in growth crunch Sydney Morning Herald, Glenda Kwek (17/1/14)

Questions

  1. Why has Australian economic growth slowed?
  2. Why has the Australian dollar been depreciating in recent months?
  3. Why did the Australian dollar fall further on the news that economic growth had slowed and employment had fallen?
  4. Find out what has been happening to commodity prices in the past three years (see Economic Data freely available online and especially site 26) How has this affected (a) the current account of Australia’s balance of payments; (b) the exchange rate of the Australian dollar?
  5. If commodity prices are in US dollars, how is a depreciation of the Australian dollar likely to affect Australia’s balance of payments?
  6. How are possible fiscal and monetary responses in Australia likely to affect the exchange rate of the Australian dollar?
  7. What determines the magnitude of the rise or fall in demand for Australian exports as the world economy grows or declines? How are the determinants of the price and income elasticities of demand for Australian exports relevant to your answer?
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Oil slipping

Oil prices have been falling in recent months. By early June they had reached a 17-month low. The benchmark US crude price (the West Texas Intermediate price) fell to $83.2 at the beginning of the month, and Brent Crude (the North Sea reference price for refining into petrol) fell to $97.7 (see chart). (For a PowerPoint of the chart below, click here.)

At the same time various commodity prices have also been falling. The IMF all commodities price index has fallen by 7.2% over the past 12 months and by 6.2% in May alone. Some commodities have fallen much faster. In the 12 months to May 2012, natural gas fell by 44%, wheat by 25%, lamb by 37%, Arabica coffee by 36%, coconut oil by 45%, cotton by 47%, iron ore by 23% and tin by 29%.

Although part of the reason for the fall in the price of some commodities is increased supply, the main reason is weak world demand. And with continuing problems in the eurozone and a slowdown in China and the USA, commodity price weakness is likely to continue.

So is this good news? To the extent that commodity prices feed through into consumer prices and impact on the rate of inflation, then this is good news. As inflation falls, so central banks will be encouraged to make further cuts in interest rates (in the cases where they are not already at a minimum). For example, the Reserve Bank of Australia cut its cash rate last week from 3.75% to 3.5%. This follows on from a cut from 4.25% on 1 May. In cases where there is no further scope for interest rate cuts (e.g. the US Federal Reserve Bank, whose interest rate is between 0% and 0.25%), then the fall in inflation may encourage a further round of quantitative easing.

But falling commodity prices are also a reflection of bad news, namely the low economic growth of the world economy and fears of turmoil from a possible Greek exit from the euro.

Update
A day after this was written (9/6/12), a deal was agreed between eurozone ministers to provide support of up to €100 billion for Spanish banks. This helped to reduce pessimism about the world economy, at least temporarily. Stock markets rose and so too did oil prices, by around 1%. But if pessimism increases again, then the fall is likely to resume.

Articles
Oil prices hit a 17-month low on China slowdown fears BBC News (8/6/12)
Oil gives up gains without signs of Fed move BloombergBusinessweek, Sandy Shore (7/6/12)
Oil Heads for Longest Run of Weekly Losses in More Than 13 Years BloombergBusinessweek, (8/6/12)
Gold plunges as Bernanke gives no hint of stimulus Live5News(7/6/12)
Oil Price Tumbles Below $83 on Weak Economy Money News(8/6/12)
World food price index expected to fall for May Reuters(6/6/12)
Oil price losing streak continues Guardian, Julia Kollewe (8/6/12)

Data
Spot fuel prices US Energy Information Administration
Commodity Prices Index Mundi
Crude Oil Price Index Index Mundi

Questions

  1. Why have crude oil prices fallen to their lowest level for 17 months?
  2. How can the concepts of income elasticity of demand, price elasticity of supply and price elasticity of demand help to explain the magnitude of the fall in crude oil prices?
  3. Would a fall in inflation linked to a fall in commodity prices be a fall in cost-push or demand-pull inflation? Explain.
  4. What are the macroeconomic implications of the fall in crude oil prices?
  5. What factors are likely to have significant impact on crude oil prices in the coming months
  6. Why is it difficult to predict crude oil prices over the coming months?
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Riding the commodities Big Dipper

Anyone investing in commodities over the past few weeks will have been in for a bumpy ride. During the first part of 2011, commodity prices have soared (see A perfect storm brewing?). This has fuelled inflation and has caused the Bank of England to revise upwards its forecast for inflation (see Busy doing nothing see also Prospects for Inflation).

But then in the first week of May, commodity prices plumetted. On the 5 May, oil prices fell by 7.9% – their largest daily amount since January 2009. Between 28 April and 6 May silver prices fell from $48.35 per ounce to just over $33.60 per ounce – a fall of over 30%. And it was the same with many other commodities – metals, minerals, agricultural raw materials and foodstuffs.

Many financial institutions, companies and individuals speculate in commodities, hoping to make money buy buying at a low price and selling at a high price. When successful, speculators can make large percentage gains in a short period of time. But they can also lose by getting their predictions wrong. In uncertain times, speculation can be destabilising, exaggerating price rises and falls as speculators ‘jump on the bandwagon’, seeing price changes as signifying a trend. In more stable times, speculation can even out price changes as speculators buy when prices are temporarily low and sell when they are temporarily high.

Times are uncertain at present. Confidence fluctuates over the strength of the world recovery. On days of good economic news, demand for commodities rises as people believe that a growing world economy will drive up the demand for commodities and hence their prices. On days of bad economic news, the price of commodities can fall. The point is that when undertainty is great, commodity prices can fluctuates wildly.

Articles
Commodities plunge: Blip or turning point? BBC News, Laurence Knight (6/5/11)
Commodity hedge fund loses $400m in oil slide Financial Times, Sam Jones (8/5/11)
Commodities: ‘epic rout’ or the new normal? BBC News blogs: Stephanomics, Stephanie Flanders (6/5/11)
Commodities Still a Bubble – But Prices May Continue to Rise Seeking Alpha, ChartProphet (9/5/11)
When a sell-off is good news The Economist, Buttonwood (6/5/11)
Gilt-edged argument The Economist, Buttonwood (28/4/11)
Commodities: What volatility means for your portfolio Reuters blogs: Prism Money (9/5/11)
Gold, silver rise again on debt, inflation concerns Reuters, Frank Tang (10/5/11)
Commodities After The Crash, No Way But Up The Market Oracle, Andrew McKillop (9/5/11)
Outlook 2011:Three Dominant Factors Will Impact Precious Metals in 2011 GoldSeek (9/5/11)
Energy bills set to rise sharply next winter, Centrica warn Guardian, Graeme Wearden (9/5/11)
Dollar triggered commodities ‘flash crash’, not Bin Laden The Telegraph, Garry White, and Rowena Mason (9/5/11)
The outlook for commodity prices Live Mint@The Wall Steet Journal, Manas Chakravarty (11/5/11)
Three ways to play the next commodities bubble Market Watch, Keith Fitz-Gerald (11/5/11)

Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data

Questions

  1. Why did commodity prices fall so dramatically in early May, only to rise again rapidly afterwards?
  2. Why do commodity prices fluctuate more than house prices?
  3. What is the relevance of price elasticity of demand and supply in explaining the volatility of commodity prices?
  4. Under what circumstances is speculation likely to be (a) stabilising; (b) destabilising?
  5. To what extent are rising commodity prices (a) the cause of and (b) the effect of world inflation?
  6. If commodity prices go on rising every year, will inflation go on rising? Explain.
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Precious metals getting even more precious

In the past few weeks, the prices of gold and silver have been soaring and have hit all-time (nominal) highs. Over the past 12 months, gold has risen by 31%, while silver has risen by 149% and 64% since the start of February. Part of this reflects the general rise in commodity prices (see also). Oil is trading at around $125 per barrel, up 43% on a year ago; wheat is up 66%, maize by 114%, coffee (Arabica) by 118% and cotton by 122%.

Part of the reason for the rise in the price of precious metals, however, has been the weakness of the dollar. In such times, gold and silver are often seen as a ‘safe haven’ for investors.

So why have commodity prices been rising and why has the dollar been falling? What is likely to happen to the prices of gold and silver in the coming weeks and months? Is their meteoric rise set to continue? Will the ratio of the gold price to the silver price continue to fall? The following articles investigate.

Articles
Gold and silver prices jump to new record highs BBC News (25/4/11)
Gold rises 7% in April as US dollar continues to weaken BBC News (29/4/11)
Gold and silver set new highs after S&P move Financial Times, Jack Farchy (22/4/11)
Real Interest Rates Explain the Gold Price Perfectly…Too Perfectly? The Market Oracle, Andrew Butter (25/4/11)
Silver, platinum to outshine gold Toronto Sun, Sharon Singleton (25/4/11)
Gold Bugs Beware Of Fed Extermination Forbes blogs: Great Speculations, Mark Sunshine (25/4/11)
Shock and Au: Hedging Against Fear EconomyWatch, Alice Briggs (26/4/11)
Keeping an Eye on the Gold/Silver Ratio Seeking Alpha, Evariste Lefeuvre (25/4/11)

Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data

Questions

  1. Why have the prices of gold and silver risen so much recently?
  2. Why has silver risen more than gold?
  3. Why may higher rates of world inflation make investors turn to precious metals for investment?
  4. How are future decisions by the Fed likely to affect the price of gold?
  5. According to the efficient capital markets theory (strong version), the current price of a commodity should already reflect all knowable factors that are likely to affect the price? Does this mean that speculative buying (or selling) is pointless?
  6. How is the price elasticity of supply of silver and gold relevant in explaining the magnitude of their price movements?
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A perfect storm brewing?

Are we heading for ‘perfect storm’ in commodity production and prices? Certainly the prices of many commodities have soared in recent months. These include the prices of foodstuffs such as dairy products, cooking oils and cereals, crude oil, cotton, metals and many other raw materials. The overall world commodity price index has risen by 28% in the past 12 months. The following are some examples of specific commodities:

Price rises in the 12 months to February 2011

• Wheat 62%
• Maize 59%
• Coffee 70%
• Beef 39%
• Sugar 46%
• Palm kernal oil 142%
• Soybean oil 50%
• All food price index 32%
• Crude oil 20%
• Cotton 132%
• Fine wool 55%
• Softwood timber 25%
• Iron ore 78%
• Copper 29%
• Tin 55%
• All metals index 58%
• Rubber 79%.

The problems are both short term and long term, and on both the demand and supply sides; and the effects will be at micro, macro and global levels. Some hard choices lie ahead.

The following webcast, articles and reports explore both the current position and look into the future to ask whether rising commodity prices are likely to continue or even accelerate.

The first link is to a BBC World Debate which considers the following issues: “Is scarcity of natural resources a serious challenge for developing and advanced economies? How great is the risk that scarcity might lead to conflict, both within and between nations? Might a scramble for resources lead to a retreat from globalisation and to greater protectionism?”

Webcast
World Debate: Resources BBC World Debate, Louise Arbour, President and CEO, International Crisis Group; James Cameron, Global Agenda Council on Climate Change; He Yafei, Ambassador and Permanent Representative of China to the UN; Malini Mehra, Founder and CEO, Centre for Social Markets; Kevin Rudd, Minister of Foreign Affairs, Australia (19/1/11)

Articles
Global Food Prices Continue to Rise Reuters, Steve Savage (7/3/11)
The 2011 oil shock The Economist (3/3/11)
Global Food Prices Will Probably Be Sustained at Record This Year, UN Says Bloomberg, Supunnabul Suwannaki (9/3/11)
Food prices to stay high as oil costs, weather weigh livemint.com, Apornrath Phoonphongphiphat (9/3/11)
‘Perfect storm’ threatens agriculture in developing nations Manila Bulletin, Lilybeth G. Ison (9/3/11)
IMF sees no immediate respite from high food prices Commodity Online (7/3/11)
Drought, supply, speculation drive world food prices to record high NZ Catholic (8/3/11)
The Factors Affecting Global Food Prices Seeking Alpha, David Hunkar (7/3/11)
World food prices climb to record as UN sounds alarm on further shortages FnBnews (India), Rudy Ruitenberg (9/3/11)
Food crisis: It’s a moral issue for all of us New Straits Times (Malaysia), Rueben Dudley (8/3/11)
Oil prices: Green light from the black stuff Guardian (5/3/11)
Cotton hits $2 a pound Guardian, Terry Macalister (17/2/11)
Supermarkets are raising prices faster than inflation, says UBS The Telegraph, Philip Aldrick (1/3/11)
What next for commodity prices? BBC News, Jamie Robertson (5/5/11)

Reports
FAO Cereal Supply and Demand BriefFood & Agriculture Organization, United Nations (March 2011)
Rising Prices on the Menu Finance & Development (IMF), Thomas Helbling and Shaun Roache (March 2011)

Data
Commodity prices Index Mundi
Commodities Financial Times, market data

Questions

  1. Identify the various factors that are causing rises in commodity prices. In each case state whether they are supply-side or demand-side factors.
  2. How can the price elasticity of demand and supply, the income elasticity of demand and the cross-price elasticity of demand be used to analyse the magnitude of the price rises?
  3. To what extent are rising food prices the result of (a) short-term (i.e. reversible) factors; (b) long-term trends?
  4. Why are food prices in the shops rising faster in the UK than in many other countries?
  5. To what extent is the future of food security and prices and moral issues?
  6. Why may current oil price rises become an opportunity for the future?
  7. What might be the respective roles be of government, business and consumers in responding to natural resource constraints?
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