Not only do most people not follow commodity prices but, for the general public, the term commodity prices has come to be almost synonymous with oil. Consequently, the recent sharp fall in oil prices - the 25% drop from the July 14 peak was the sharpest fall in many years - has been hailed as not only a boon to consumers, and hence to the global economy, but as signaling the end of the general commodity boom.
Nothing could be further from the truth.
Oil is to commodities as California is to the US. True, oil - or the energy sector as a whole - is a commodity or cluster of commodities and, arguably, crude oil is THE single most important commodity. But there is no law or inherent reason why oil and commodities should act similarly, let alone identically - even if they have run in tandem for the last three-plus years and may well continue to do so.
Let's imagine a simple scenario in which the US economy slows or suffers a mild recession in 2007.
In this case, oil prices very likely will fall, or at least not rise further, because of the weight of US energy consumption and the indirect fall-out on other economies. But what will happen to other commodities? The answer is that, in most cases, their prices will rise because the US economy is not the dominant factor in their supply-demand balance.
This is most dramatically the case in the base metals complex-zinc, lead, nickel etc. Take copper, which now costs around $3.40 a pound, compared to less than 70 cents in 2002 and an all-time record of around $1.20/pound until the current boom. The slump in the US housing market will - probably has - hurt copper demand, but has the price fallen? Hardly. Why? Because the world is no longer a US pond; there are other big fish in the sea.
Writing about "huge demand for zinc and nickel" generated by "massive expansion in â€¦ steel production," the Financial Times (October 24) quoted a Credit Suisse analyst as saying "China's new rail and underground spending program in the next five years could be bigger than the rest of the world's total investment in the last 20 years." (That's a statement that warrants reading twice). Similarly, India's demand for copper will grow at 16% per year, according to Credit Suisse, and its share of global copper demand will rise from 4% to 10% by 2010.
In metals, price is being driven by demand. In grains, supply is the problem. Did you know that wheat prices touched a 10-year high on October 17? Or that wheat, corn and other grain prices are in a strong uptrend? You should - because, unlike nickel and lead, you eat the stuff and it is part of your household budget virtually every day. You should also know that the problem in the grains is not demand from the Chinese or other new players, but the age-old problem of drought. US wheat production this year was down some 14%, while the Australian crop is now estimated at about 40% of last year's - so bad is the water situation Down Under.
These trends ensure that the price of many items in your shopping basket will go up.
However, whether your overall basket of purchases will cost more is uncertain. Downward pressure on prices in sectors such as clothing and shoes (the Chinese again) will provide a counter-balance, but if oil prices go back up it is likely that households will feel pinched. Insult will be added to injury by economists, statisticians and central bankers, who will proudly announce that "core inflation" - which is conveniently defined to exclude "volatile items" such as food and energy, and can be refined further to eliminate other troublemakers - is under control. If it should seem to be getting out of control, interest rates will be raised to "cool off" the economy. The one thing that won't go up is wages, unless you are in one of those sectors where there is a shortage of labor. Funnily enough, very few people are.
The prospect of continued price rises across most commodities in 2007 may well explain the Federal Reserve's repeated insistence that the US economy faces an ongoing inflationary threat. At the same time, it acknowledges more clearly in its most recent statement that the economy is slowing, as the housing market slumps. Expect, therefore, to hear the dreaded 'stagflation' word being more openly bandied about - although only after the mid-term elections are out of the way.
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