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Commodity price drivers

Commodity price movements are extremely volatile. Too volatile, most would argue, making shorter term planning, budgeting and decisions extremely difficult.

Most analysts and economists were surprised by the recent exceptional upswing just before the financial crisis. Just when they thought that a supper cycle was here to stay, they were caught off guard in the drop in prices and profits, only to be surprised again by quick price recovery.


The composite Index for All Commodities by the International Monetary Fund (IMF) shows a year on year increase of 62%, between June 2007 and June 2008, just before the financial crisis. During the crisis, commodity prices dropped sharply, by 45.5% year on year in March 2009. The latest data for March 2010, shows a recovery of 45.9% year on year.
Volatility is driven by many factors, like demand and supply mismatch, speculation, greed versus fear balance, currency movements, operational cost escalation, future expectations, natural disasters, and monopolistic business practice.Three fundamental factors in demand are changes in GDP, exchange rates, and inflation.

Economic growth and GDP

China and some other developing countries, including India, Brazil and Russia, have shown remarkable increases in demand for commodities in the last decades, to support their economic growth and development.
According to data from the National Bureau of Statistics of China, real GDP growth had increased by 140% in nine years, from 2000 to 2009, an average annual increase of 10.05%.
To sustain this growth, lots of commodities are needed. China is expected to consume 47% of the world's steel in 2010 (World Steel Association). China sold more cars domestically in 2009 than the USA, 13.6-million compared to only 10.4-million cars and light trucks in the USA (China Association of Automobile Manufacturers).
Growth goals of 1.3-billion Chinese and 1.1-billion Indians, together with the needs of other developing and developed countries, translates directly into demand for commodities.

Exchange rates

Commodities are primarily denominated in USA dollar prices. If the USA dollar appreciates (strengthens) or depreciates (weakens) against the Euro, or against a trade weighted basket of currencies, named nominal effective exchange rate, it impacts the dollar value of commodities directly.
If the dollar depreciates, commodity prices must increase to offset the loss in value due to weaker currency.
For example, the USA dollar had depreciated from a low of $/€ 0.85 in June 2001, to $/€ 1.57 in July 2008, an 84.7% depreciation. The IMF Index for All Commodities had increased by 252.2% during this period, an average annual increase of 16.27%.

Demand pulls, cost pushes inflation

Despite leads and lags among commodities, price movements are inherently correlated, since demand pull factors are broadly the same for all commodities.
Drivers like economic growth, that cause price increases in some commodities, lead to price increases in other commodities used in production and related processes.
If demand for steel rises, it leads to a demand and price increase in manganese, used in steel production. Demand pulls up cost.
Cost pushes prices and inflation. Operational cost escalation applies, for example, if the oil price rises, increasing prices in all other commodities due to mining and transport cost increases.
During periods of high inflation, increasing risk, and uncertainty, gold is seen as a hedge, thus increasing gold demand and price.

* Dr Johannes Jordaan is senior economist at Economic Trend SA, based in Pretoria, visit www.economictrendsa.co.za

 

 

 

 

 

 

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