Friday, 28 November 2014

Commodity Prices – Swings and Roundabouts

Commodity markets had gone off in their own direction but are now back on track to help out with the global economy

The global economy has suffered more downs than ups over the past few years but lower commodity prices will provide some long needed cheer.  Long after the onset of the global financial crisis, prices for everything from copper to vegetable oil continued to rise stoked by demand from places such as China.  Weaken global demand has finally taken affect and relief in on the way for consumers everywhere.  It is likely to provide a bigger boost than just a bit of extra cash.

A guide to the road ahead

Commodity markets often follow their own roadmap.  Demand for different materials can rise and fall depending on changes in technology or consumption patterns.  The rising wealth of China and India has pushed up prices for everything from gold to milk powder.  New fracking technology has lowered the price of oil while corn became more expensive due to its use in producing ethanol in the United States. 

Supply further complicates matters as rising demand for any commodity will prompt companies to increase output but this often takes time.  There is a lag of a year or so for farmers to shift from growing one crop to another and even longer for a new mine or source of oil to be developed.  The changing demand and the delayed response on the supply side means that twists and turns in the commodity markets are often accentuated.

Back on the map

Prices in the commodity markets had long been out of kilter with the slump in global demand but this seems to be over.  The price of oil, which has been making news recently, is indicative of this new trend.  Increased output in the US coupled with a tailing off of demand from energy-hungry China has resulted in a sharp turnaround in prices.  High prices for commodities such as oil often do not last as more money gets spend on both finding more oil as well as on increasing energy efficiency to lower money spent on oil.  Both of these factors act to stop the price of oil getting out of hand. 

Market correcting forces move in both directions and also work to prevent excessive falls in prices.  Investments in producing commodities are put on hold if prices drop back and low supply tempers a decline in prices.  Lower prices also mean that interest in using resource more efficiently tends to fade.  This is why commodity prices tend to fluctuate in big swings of boom and bust.  With the world economy have just endured a period of high prices, the commodity market seems to be swinging in the opposite direction.  Considering the big swings in commodity prices, this trend is not likely to be reversed any time soon. 

Heading in the right direction

The benefits of lower commodity prices extend beyond the obvious effects of cheaper prices at the petrol pump, on our gas and power bills, and when stocking up at the supermarket.  Less money will go to places such as Saudi Arabia and Russia, where high oil prices only add to the riches of already wealthy individuals, and consumers across the globe will instead have more money in their pockets.  As such, the global economy will benefit as this extra cash will likely to spent rather than piling up in the bank accounts of rich Saudis or Russians.

A further benefit of lower commodity prices is that cheaper commodities mean lower inflation and lower inflation allows more scope for looser monetary policy.  An uptick in inflation would be one excuse that central banks would use to raise interest rates.  But with inflation likely to be subdued (and deflation becoming more of a concern), interest rates are more likely to stay at their current low levels or hardly rise at all when interest rates are eventually raised.  The absence of inflation could even result in a long-needed rethink of what central banks should be doing in terms of monetary policy.  That may work out to be even be more valuable than a few extra notes in your pocket.

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