Selasa, 23 April 2013

What do commodity prices tell us?

Commodity prices on average are down about 15-20% from their all-time highs two years ago, but they remain very high relative to their 2001 lows. The recent weakness in commodity prices could be explained by slower economic growth here and in places like China, but commodity prices are not weak enough to point to any monetary policy errors (i.e., deflationary risk).  

The above chart shows the CRB Raw Industrials Index going back to 1981. This index is composed of basic industrial commodities, many of which do not have associated futures contracts. It's arguably the best index to follow for clues as to the health of global manufacturing activity. Prices today are down 15-20% from their recent all-time highs, but remain very high relative to their 2001 lows—130-150% higher. While this is consistent with the observation that economic growth in recent years has been disappointingly slow, prices are still at lofty levels compared to a decade ago, and much higher than what we saw in late 2008 when global manufacturing suffered a major decline.

This next chart shows inflation-adjusted value of the broader Spot Commodity Index, which adds foodstuffs to the Raw Industrials Index. One thing that stands out is that, despite huge gains since 2001, most commodity prices today are lower in real terms than they were in 1970—on average, commodity prices have risen by less than the rate of inflation for over 40 years. Commodities rose in real terms in the 1970s (after being largely flat throughout the 1960s), a period during which monetary policy was generally accommodative, inflation was rising, and there was lots of speculative purchasing of commodities and other physical assets for their inflation-hedging properties. 

Commodities fell significantly in the 1980s and 1990s, when monetary policy was generally tight and inflation was falling. The Fed began to ease in 2001, and commodity prices have risen significantly since then, suggesting that—as was the case in the 1970s—monetary policy has played a significant role in driving prices higher in the past decade. From this perspective, it would appear that the Fed's policy accommodation over the past decade has been enough to remove the deflationary impact that monetary policy had on commodity prices in the 1980s and 1990s, but not enough to create new inflationary pressures.

The chart above compares the price of gold with the CRB Spot Commodity Index. Note that gold tracked the ups and downs of other commodity prices fairly well from the early 1980s until 2011, when commodity prices fell but gold continued to rise and remained elevated. The latest decline in gold could be the market's attempt to realign gold and commodity prices. I don't see evidence of deflationary pressures here, but rather a decline in gold prices from what were arguably very high levels that in turn were likely driven by speculative activity and geopolitical risk concerns.

The first of these two charts shows the nominal level of crude oil prices (using the futures contract tied to domestic light crude), while the second chart shows the inflation-adjusted level of Arab Light Crude. Crude oil is unique among commodity prices, since it peaked in 2008 and is higher in real terms today than it was in 1970 or 1980. In general, with the brief exception of the spike in prices in 2008, it can be said that crude oil today is almost as expensive, relative to other things, as it has ever been.

Because energy has become so expensive in real terms, we have found ways to use it more efficiently, with the result that energy consumes a much smaller portion of personal consumption today than it did in 1980 despite being more expensive. Expensive crude prices have also helped bring us the miracle of modern fracking technology, which in turn has given us very cheap natural gas.

Industrial metals prices tell roughly the same story: prices have been volatile but range-bound for the past 6-7 years, and they are still much higher today than they were at their 2008 and 2001 lows. Copper is five times more expensive today than it was in late 2001, while industrial metals prices on average are 3 and a half times more expensive. The thing to note here is not that prices have broken down of late, but that they are still very high from a long-term historical perspective.

The chart above shows prices for a small basket of relatively obscure commodities (hides, rubber, tallow, plywood, red oak). It is now at an all-time high. No evidence here of any economic weakness.

To sum up, I don't see much to worry about in the prices of commodities. They have weakened of late, but on average they remain at levels that just a decade ago would have seemed exceedingly high.

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