Wednesday, October 1, 2014
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Commodities on the Rise

SEOUL – The commodity super-cycle – in which commodity prices reach ever-higher highs, and fall only to higher lows – is not over. Despite the euphoria around shale gas – indeed, despite weak global growth – commodity prices have risen by as much as 150% in the aftermath of the financial crisis. In the medium term, this trend will continue to pose an inflation risk and undermine living standards worldwide.

For starters, there is the convergence argument. As China grows, its increasing size, wealth, and urbanization will continue to stoke demand for energy, grains, minerals, and other resources.

For example, the US consumes more than nine times as much oil as China on a per capita basis. As more of China’s population converges to Western standards of consumption, demand for commodities – and thus their prices – will remain on an upward trajectory.

Of course, not all commodities are equal. For example, although the case for copper seems straightforward, given that it is a key input for wiring, electronics, and indoor plumbing, a strong bid for iron is not as obvious, given the Chinese infrastructure boom that already has occurred in the last two decades.

Worst-case estimates have China’s real GDP growing at around 7% per year over the next decade. Meanwhile, the supply of most commodities is forecast to grow by no more than 2% annually in real terms. All else being equal, unless China’s commodity intensity, defined as the amount of a commodity consumed to generate a unit of output, falls dramatically, its demand for commodities will be greater this year than it was last year.

As long as China’s commodity demand grows at a higher rate than global supply, prices will rise. And the rapid economic growth that China’s leaders must sustain in order to lift enormous numbers of people out of poverty – and thus prevent a crisis of legitimacy – places a floor under global food, energy, and mineral prices.

To be sure, intensity of use has fallen for some commodities, like gold and nuclear energy; but for others, such as aluminum and coal, it has risen since 2000 or, as is the case for copper and oil, declines have slowed markedly or stalled at high levels. As the composition of China’s economy continues to shift from investment to consumption, demand for commodity-intensive consumer durables – cars, mobile phones, indoor plumbing, computers, and televisions – will rise.

There is also the issue of the so-called reserve price (the highest price a buyer is willing to pay for a good or service). The reserve price places a cap on how high commodity prices will go, as it is the price at which demand destruction occurs (consumers are no longer willing or able to purchase the good or service).

For many commodities, such as oil, the reserve price is higher in emerging countries than in developed economies. One explanation for the difference is accelerating wage growth across developing regions, which is raising commodity demand, whereas stagnating wages in developed markets are causing the reserve price to decline. By implication, if nothing else, global energy, food, and mineral prices will continue to be buoyed by seemingly insatiable emerging-market demand, which commands much higher reserve prices.

Ultimately, emerging economies’ absolute size and rate of growth both matter in charting commodity demand and the future trajectory of global commodity prices, with per capita income clearly linked to consumers’ wealth. If people feel rich and enjoy growing wages and appreciating assets, they are less inclined to cannibalize other spending when commodity consumption becomes more expensive. They just pay more and carry on.

Of course, upward pressure on commodity prices also stems from supply-side challenges. It is not just that global supplies of resources are increasingly scarce, but also that supplies are increasingly falling into inefficient hands.

Around the world, governments are taking greater control of resources and imposing policies that hamper global production and ultimately force prices higher. (Following the recent fracas surrounding Argentina’s nationalization of Yacimientos Petrolíferos Fiscales (YPF), Australia’s 2012 mining tax on iron and coal companies is a stark reminder that such tendencies are not limited to emerging-market politicians.)

Such price increases can prove particularly inflationary in countries that import commodities. And they can be disastrous to exporting economies, which risk rapid currency appreciation and thus a loss of competitiveness.

Of course, technological advances, like hydraulic fracturing (“fracking”) in the shale-gas industry, could increase supply and therefore lower prices. But mounting environmental challenges, and the limited availability of commodity substitutes, suggest that a reprieve on commodity prices is not near.

There is a perennial temptation to focus on – even to overemphasize – the short-term, tactical drivers of commodity-price movements, at the expense of giving longer-term, structural factors their due. While short-term factors – for example, political instability, weather-related disruptions, and speculative activity – are important determinants of prices, they tell only part of the story.

The economic fundamentals of supply and demand remain the key factors in driving the direction of commodity prices and determining whether the commodity super-cycle will persist. In practical terms, this means that oil prices, for example, are more likely to hover near $120 per barrel over the next decade, rather than $50; and we are unlikely to see a $20 barrel of oil ever again.

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  1. CommentedJohn Champagne

    China's leaders must sustain economic growth to lift people out of poverty (or so we believe) because, while our economic paradigm recognizes *private* property rights and allows amassing of private wealth, there is an almost complete absence of any accurate representation of the value of natural wealth, which should be vested in all people equally, from the economic calculus. If we place fees on the extraction of natural resources (and on the putting of pollution) and set them just high enough so that random surveys indicate that we are not depleting these resources at an unacceptably high rate (or putting too much pollution), we could then share the fee proceeds among all the world's people. The idea, the philosophical principle, that says natural wealth should be shared would then be manifest in reality. The rate at which we deplete resources might be sufficiently slowed so as to mitigate the more severe consequences of resource scarcity on the economy and society and, consequently, a sustainable civilization could be established.

    Economic growth can alleviate poverty, but only until natural resources are depleted and civilization collapses, and only for those within the sphere of the expanding economic activity. Sharing of natural wealth (assigning appropriate fees; sharing the proceeds) can prevent (or slow to manageable rates) the depletion of natural resources and could end extreme poverty throughout the world.

  2. CommentedJohn Champagne

    The commodities super-cycle would appear to be an inevitable symptom of a civilization approaching the absolute limits of what can be effectively exploited from available natural resource stocks. The super-cycle shows a civilization headed for collapse. Appropriate fees on extraction can, by slowing overall rates of extraction, extend availability out farther into the future. This would afford extra time for the economy and society to develop alternatives to the scarce resources and the fees would provide the necessary additional economic incentive to recycle rather than discard scarce resources.

  3. CommentedJonathan Lam

    Gamesmith94134: Commodities on the Rise
    “And the rapid economic growth that China’s leaders must sustain in order to lift enormous numbers of people out of poverty – and thus prevent a crisis of legitimacy – places a floor under global food, energy, and mineral prices.”
    I would remind Ms. Dambisa Moyo of the smog and real estate in Beijing that another new floor on the ceiling to the commodity could be disaster and they recognized its urge to growth may not subject to expansion further. The present China’s domestical economic policy is implementing rapid heists on the capital assets in the financial by cutting it target to 8% from 15%. If Ms. Moyo is eyeballing the $3 trillion US reserves and how commodity would be necessitated for its perpetual growth; there are another substitutes like Mr. Ritesh Kumar Singh had suggested trends on green industry and mass transit system are advancing in its infrastructural developments.
    Since its members in its Politburo became allergic more to smog than noise, its citizens are pedaling. Now, there are bikes returning to the metros. As in iron and aluminum, China kept its mills running to produce even when the demand in Europe came short. Economy to expand and employment to buoy, they had surpluses docked in warehouses, ore and coal price are sustained; so is the oil and gold. Besides, china is a communist country that can change its policy on who can own a car or how prosperity outlook the Westerners portrays, it shifts it wind without compromising to the public’s criticism, absolutely. At present, the moderate turn to its domestic challenges like inflation and capital assets, competitive price on commodity would undercut its growth and employment; and I would consider it is a seller’s market which is under the influence of the monetarism and not economics.
    However, if commodity plus labor made marketable valued added goods; then, we could have a different story. Seriously, we do need the stable price to make productivity and consumption; we need employment and governments to lead us to a positive growth and not to pursuit price enhancement. I recalled the frog-leap year when oil jumped from 85-120-147, it was not scarcity as the tankers were used as floatation devise in the straits of Hormuz; but many went bankrupt. I would recommend Ms. Moyo to study more of the labor strikes in Nigerian oil and Brazilians mine to navigate in the short-term and long-term adjustments which are current with the situation we’re having now in its macro-economic rush.
    Perhaps, there is nothing I can do whether the gas price could stall my car on the highway; but I hope the commodity trader would contemplate what if there is a wholesale available when the banks go kaput. I think Chinese may as well pipe its gas from Russian to fart, and eat it wind off Siberia instead of rice. Focus on growth and productivity. As an America, I hope China is not dumping our bonds to buy oil or food. It is terrible.
    May the Buddha bless you?

  4. CommentedNathan Coppedge

    It is also worth mentioning that there is potential with space mining and (eventually) off-earth enterprises. I suspect someone will design robots that can construct an energy facility at some point. The only question is, how close to the sun? Perhaps nanotechnology of certain types could begin building airconditioned cities around the sun in the next 200 years. I'm optimistic. Although the miracles of philosophy are not always possible in other disciplines, certainly there are disciplines which have miracles of their own. Maybe all of them.

    The miracle of commodities is its sort of relative. Consumer demand exists regardless of price. The real material questions of starvation and medical services are supposedly resolvable when there is enough wealth. Consider for example, that part of the value of money is to 'throw its weight around' resulting in free services for some, if not all, sectors of populations. As long as people remain consumers and spend the money that they have, it doesn't matter how many services are provided, it is equally effectual, or better.

    I suspect that commodity prices rise in general whenever the economy improves. There are economists that call this a fallacy, but consumer demand is partly a function of the quality of services, which inevitably improves, or seems to improve, when the economy is doing well. The question is simply whether the quality is trivial, and whether the improvement is trivial; the two things are really like opposites; Improvement only occurs when businesses profit, and quality is partly a matter of perspective. Economic health is something like the combination of good consumer psychology and efficient production management. If that is not the case, then there is the emergence of a non-relative economy in which inflation, competition, or commodity prices destroys investor confidence. Really, if industries are reliable and there is good consumer psychology, then everything is macro-economics.

  5. CommentedCarol Maczinsky

    I would rather say that china will quickly approach the limits of growth and destroy its economic base, while Occidental competitiveness gets a boost.

  6. CommentedMacro Themes, Trends and Trades

    You are definitely right on global demand for commodities as a whole, but that doesn't mean that prices will rise further. I believe there are three important issues that you are not treating - 1/ China's investment cycle, 2/ the rise in production capacity, 3/ Investors' exposure.
    THE most important factor is that there has been an investment boom in China that is not only not sustainable but threatening Chinese growth. Even the Chinese authorities accept that fact. This boom had an exceptional impact on metal demand (read RBA's research for instance). The biggest part of this demand is past. And even if urbanisation programs is going to compensate some of that demand, it will probably not fully replace it.
    The second one is the opening of new capacities that occured through this demand shock (tar sands in Canada, Shale Oil in the US, new mines everywhere in Australia, Africa, etc...). It is not just a question of demand, but supply as well. And supply capacities have increased significantly in the last few years. There is a reason why ALL the board of big mining groups have been replaced last year. It is because they all over-invested because they had excessive faith in the super-cycle.
    Third, the level of market expectations reflected in current prices is already very high. More specifically, the amount of money invested in commodity funds (see IMF data for instance) is staggering. If investors start reducing their exposure to that "miracle" asset class, then we will see a much bigger drop.
    So all in all, like the RBA, I would tend to believe that the super cycle is over. That doesn't mean that we are already in a bear market. Unless investors loose faith in the asset class.

  7. CommentedRitesh Kumar Singh

    The obvious counterpoint to this article would be: Will not the increase (expected or actual) excite the investors to invest in increasing the supply of commodities or in finding substitutes (e.g. shale gas for oil/gas) and that would contain the excessive price rise.

    Economic logic supports the above hypothesis. But like all economic theories, law of supply too is based on several assumptions in particular….that there’s no supply constraints.

    But when it comes to resources (agri. or non-agri. commodities) there are several supply constraints that prohibit the increase in supply to match the growing demand signaled by rising prices, for instance, limited arable land or diversion of land for industrial/housing (for agri. items); for non-agri. items, such constraints can be - preservation for future, pollution control, diverting for value addition domestically using trade policy e.g. fluorspar or rare earth metals by countries like China. The author seems to be right on the expected rise in prices of the commodities in the next decade.

    One downside risk can that can change things dramatically is innovation for substitutes (e.g. shale gas for oil)…but what about substitute for milk or rice or eggs? Besides, many substitutes will be commercially accepted only when price of conventional commodities become as their non-conventional substitutes. In case of India, eco-friendly hydro power has not replaced coal based thermal power because hydro power is not available at comparable price plus there can be geographical limitations.

    Hope innovation happens.

  8. CommentedProcyon Mukherjee

    An extremely misleading article, given that Base metal prices have not moved up since 2008 as attached: http://www.kitcometals.com/ and the Forbes article that was published yesterday is speaking of an impending crash in the Iron Ore prices: http://www.forbes.com/sites/timtreadgold/2013/03/13/iron-ore-price-crash-looms-signalling-an-end-to-the-commodities-super-cycle/

    Almost every commodity is projected with an impending surplus in the next two years, it is just that the flow of money into commodities continue unabated, resulting in stocks that have almost no chance of getting liquidated in a short span. In many commodities the inventory runs at record levels, while new capacity is being created as the flow of money continues to fuel further investments.

  9. Portrait of Pingfan Hong

    CommentedPingfan Hong

    "In the medium term, this trend will continue to pose an inflation risk and undermine living standards worldwide": if the rise in commodity prices is mainly driven by the increased demand of emerging economies, as claimed by the author, then the statement quoted above is false and in contradiction to the analysis of this author, because it implies that the rise in commodity prices is a result of improved living stardards worldwide.

    If, on the contrary, the rise of commodity prices is mainly driven by financialization and speculation, it undermines the living stardards worldwide.

  10. CommentedZsolt Hermann

    The article's philosophy and predictions are based on a static, dream-like scenario, many experts and politicians would like to believe in, that constant quantitative growth, expansion can continue infinitely, with ups and downs but unstoppingly.
    But if we tried to look at the present situation from an outside perspective, the same leaders and experts are like machinists on a steam train, feeding the engine that is speeding ahead...except that it has run out of rails and is heading towards the cliff.
    This excessive over production, over consumption, quantitative growth model is unsustainable, as it is breaching every natural law in existence. It has no natural, logical bases.
    And since humanity, human beings are parts of the natural system and not some kind of angels floating above it, those natural laws are binding to us as well.
    Outside of boardrooms, parliaments, economist chambers most people already know this, moreover huge part of the public already feels it on their skin.
    The present level, or change of commodity prices is irrelevant.
    As over 90% of present human activity is unnatural and obsolete, and by the laws of the system will cease to function in a short time, commodity prices as many other "important" measurements of our present life will lose their meaning completely.
    The only important measurement is how well humanity adapts to the natural system surrounding us, this is the only factor that will decide our future.

      CommentedEdward Ponderer

      I tend to agree with Zsolt Hermann on both the points of economy and ecology -- further, there is a deadly synergy in the mix. In this regard, I must challenge Nathan Coppedge's more optimistic outlook on the economy which seems to depend upon the assumption that new paradigms in science and technology will save the day.

      Regarding Mr. Coppedge's first comment about hopes for "space mining and (eventually) off-earth enterprises," about which the present response appears to be a continuation -- the "eventually" may be a long ways off -- way too long. Just what are we mining, from where, and how cheaply can you get it back hear (payload pound per dollar is a very nasty nickel and dime to death issue here). The reality of recent years for anyone who has been inside JPL or the broader NASA system, are all too well aware of the real world politics going on, and how long-term development is being shifted to short term "sexy" missions that do gather some good basic science data -- but are mainly a PR show (like MARS twitters and hopeful support of Disney Wall-E). The real possibilities of hope are with the exo-planets if anything, and the best shot at one of those is, at present technology, about a 30,000 year one way trip. In short, space is not a very hopeful resources option for this century -- to be revisited in the 22nd century if and when we get there.

      As to recycling, from what I understand it is a nice thing to tell grade school kids, but in reality it is often involves more waste than is recovered, and is at best scraping your heels along the gravel as the car races for the edge of the cliff. Worse, it gives the excuse to up needless production even further by staying protests through corporate "good citizenship" claims.

      As to energy, I hear shale oil -- and I hear that it is extremely dangerous in its potential aftereffects. Solar -- even at 100% efficiency, will require a collection area of about 1/4 the size of North America to be a practical substitute for oil. This does not even begin to address the nightmarish complications of distributions, weather, etc. I'm not sure what other miracle, not merely incremental source, is perceived to be coming down the line?

      And then there is nanotechnology. Yes, fantastic possibilities of faster analytic engines to power fantastic gizmos on cell phones and even more realistic virtual reality games. And yes, some nitch medical, filter, and micro electro-mechanical system level interfaces. But what are the risks connected with this interface of biology, chemistry, electronics, and quantum physics. One problem is that let loose into water or air, carbon nano-tubules -- the hope for future electronics, Buckminsterfullerene ("buckyballs") -- a potential chemical delivery system, both diffuse with the greatest of ease through cell membranes. To a limited extend, the nanotubules seem to do no harm, but at far lower densities, bucky ball leave fish brain dead. The is no theoretical predictions possible for such matter, the quantum-biochemistry is just way to complex to predict. -- And these are with the simplest of useful structures. Goodness know what Murphy's Law has to offer as varieties and mixes increase. Present ecological problem may well soon become "the good old days" once a three-mile island, Chernobyl, or the present Japanese Tsunami fall out meet there match in the nano structures world.

      Beyond all this, is the simple reality that non-military R&D money is evermore being directed into what shows in next quarter's profits, that is, the next cell phone gizmo. or otherwise drying up...

      CommentedNathan Coppedge

      Because real resources continue to exist, and there is growth of recycling and energy industries and more efficient materials, and some figures continue to throw their wealth around, it is not appropriate to predict an economic disaster. Perhaps an environmental one---is the atmosphere losing oxygen for example?---or a psychological one---what happens to generations who partially believe that they are 'post-post-modern' but without reassurance of the constant emergence of new paradigms---etc.

      However, I see the point with deforestation in particular. I am surprised there has not been a greater initiative to build more artificial trees (which were recently designed---see for example: http://shiftboston.org/competitions/2011_treepods.php ) these provide both oxygen and electric energy.

  11. CommentedChee-Heong Quah

    Persistent general price increase can only occur if the money supply is consistently increased in a rate faster than the rate of production.

    To blame China for persistent price increase is just fallacious. If the rate of production in the world is increasing in the same pace with the rise in money supply, there is no increased inflation. As simple as that.

    And we all know till today the Fed is the supplier of money to the world.

    Read Milton Friedman's works for details.

    Quah, Chee Heong

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