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Monday 09 May 2011
Telegraph.co.uk Home News Sport Finance Comment Blogs Culture Travel Lifestyle Fashion Tech Jobs Dating Offers Companies Comment Personal Finance Economics Markets Your Business Olympics Business Business Club Money Deals Ambrose Evans-Pritchard Jeff Randall Damian Reece Jeremy Warner Richard Fletcher Kamal Ahmed Alistair Osborne James QuinnRoger Bootle
Why we should hope for a large fall in commodity prices Last week saw sharp falls in oil and commodity prices, including a record daily fall in the price of oil – of $12 a barrel. Oil prices are still some 40pc higher than last year's average and 80pc higher than the average in 2009 Photo: Reuters By Roger Bootle 8:13PM BST 08 May 2011Comments
And falls occurred across all categories of commodities from precious metals to industrial metals and foodstuffs. Could this be the beginning of something big?
If it is, then things have to develop a long way from here. Oil prices are still some 40pc higher than last year's average and 80pc higher than the average in 2009. It is a similar story with soft commodities. Wheat is still 30pc above last year's average. Nevertheless, as Mao-Tse-Tung is supposed to have said: "The journey of a thousand miles begins with a single step". (Mind you, so does the journey of a single step.)
If commodity prices do fall a long way, it shouldn't be that surprising. In fact, I have been waiting for this for some time. The fundamental reason why they are weakening now is the evidence of softer growth in the world economy, accompanied by a mini revival of the dollar.
Over here, of course, we have had weak GDP and consumption figures but also weak PMI surveys for both manufacturing and the service sector. Interestingly, in the US too, although Friday's employment figures were OK, there have also recently been some soft numbers. Meanwhile, Japan is laid low by the results of the recent disaster and in the eurozone there are early signs of a slowdown.
Why should the world recovery have started to slow? I think the most likely explanation is the very increase in oil and commodity prices which now seems to be reversing. Across most of the world, higher prices have sharply reduced consumers' real incomes and increased firms' costs.
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05 May 2011Yet changes in the health of the world economy may not be the whole story. There has been a raging controversy about the extent to which speculation has played a role in driving commodity prices. At the least, it should be obvious that speculation can have an enormous impact over short time periods.
Last week the price of oil fell by 10pc. Are we to suppose that demand from the world economy has fallen by enough in one week to cause a fall of that magnitude? Of course this is nonsense. What has happened is that traders' views about what has happened, and may yet happen, to world demand have changed. But if a change of view (speculation) can undoubtedly affect prices in the short run then why can it not affect them over longer periods?
In theory it can. The argument against this having been important in practice is that speculators would have to be prepared and able to build up stocks (inventories). Yet supposedly there is no noticeable evidence of a build-up of inventories of commodities.
This argument has always struck me as seriously overstated. Admittedly, there has to be an increased preparedness to hold inventories. But this need not translate into an increase in inventories in practice. The price may take the strain, thereby burning off the desire to hold more stock.
This is not a point about the special characteristics of commodities. It is a fundamental point of economics. It rests on the distinction between ex-ante and ex-post demand. When the stock market report says that the price of BP shares rose because of increased demand for them, we do not expect to see this reflected in an increased number of shares in issue. We expect to see it reflected in a higher share price. So it is with commodities.
What are the implications? If all the recent weakness of commodity prices is a reflection of the incipient weakness of the world economy, that is hardly cause for rejoicing. After all, although there would be gains from stronger growth in real incomes, if the world economy were slower then this would be bad news – especially for our exports.
And exports are our great hope for recovery. What we would gain on the swings we would lose on the roundabouts. And the roundabouts could easily be more significant than the swings. If speculation has contributed a good deal to the recent strength of these prices, however, then there is scope for commodity prices to fall to an extent that is greater than what is justified by a world economic slowdown.
The future is full of surprises. If I had to put forward an idea for how the next few years could turn out much better than most analysts (myself included) are forecasting, my leading candidate would be a large fall in commodity prices out of all proportion to any weakness in the world economy.
If that happens, then we would see a dramatic drop in inflation and a sharp recovery of consumer real incomes. This would help people to absorb the effects of the fiscal squeeze. It is certainly something to hope for. And it may just happen.
Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte
roger.bootle@capitaleconomics.com
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Comments
And falls occurred across all categories of commodities from precious metals to industrial metals and foodstuffs. Could this be the beginning of something big?
If it is, then things have to develop a long way from here. Oil prices are still some 40pc higher than last year's average and 80pc higher than the average in 2009. It is a similar story with soft commodities. Wheat is still 30pc above last year's average. Nevertheless, as Mao-Tse-Tung is supposed to have said: "The journey of a thousand miles begins with a single step". (Mind you, so does the journey of a single step.)
If commodity prices do fall a long way, it shouldn't be that surprising. In fact, I have been waiting for this for some time. The fundamental reason why they are weakening now is the evidence of softer growth in the world economy, accompanied by a mini revival of the dollar.
Over here, of course, we have had weak GDP and consumption figures but also weak PMI surveys for both manufacturing and the service sector. Interestingly, in the US too, although Friday's employment figures were OK, there have also recently been some soft numbers. Meanwhile, Japan is laid low by the results of the recent disaster and in the eurozone there are early signs of a slowdown.
Why should the world recovery have started to slow? I think the most likely explanation is the very increase in oil and commodity prices which now seems to be reversing. Across most of the world, higher prices have sharply reduced consumers' real incomes and increased firms' costs.
Cook warns on UK profit
Dollar triggered commodities 'flash crash', not Bin Laden
Has the commodities bubble burst?
Ten secretive giants that control the world's commodities
Goldman Sachs says oil price fall is temporary
Oil, gold and silver plummet on global fears
Yet changes in the health of the world economy may not be the whole story. There has been a raging controversy about the extent to which speculation has played a role in driving commodity prices. At the least, it should be obvious that speculation can have an enormous impact over short time periods.
Last week the price of oil fell by 10pc. Are we to suppose that demand from the world economy has fallen by enough in one week to cause a fall of that magnitude? Of course this is nonsense. What has happened is that traders' views about what has happened, and may yet happen, to world demand have changed. But if a change of view (speculation) can undoubtedly affect prices in the short run then why can it not affect them over longer periods?
In theory it can. The argument against this having been important in practice is that speculators would have to be prepared and able to build up stocks (inventories). Yet supposedly there is no noticeable evidence of a build-up of inventories of commodities.
This argument has always struck me as seriously overstated. Admittedly, there has to be an increased preparedness to hold inventories. But this need not translate into an increase in inventories in practice. The price may take the strain, thereby burning off the desire to hold more stock.
This is not a point about the special characteristics of commodities. It is a fundamental point of economics. It rests on the distinction between ex-ante and ex-post demand. When the stock market report says that the price of BP shares rose because of increased demand for them, we do not expect to see this reflected in an increased number of shares in issue. We expect to see it reflected in a higher share price. So it is with commodities.
What are the implications? If all the recent weakness of commodity prices is a reflection of the incipient weakness of the world economy, that is hardly cause for rejoicing. After all, although there would be gains from stronger growth in real incomes, if the world economy were slower then this would be bad news – especially for our exports.
And exports are our great hope for recovery. What we would gain on the swings we would lose on the roundabouts. And the roundabouts could easily be more significant than the swings. If speculation has contributed a good deal to the recent strength of these prices, however, then there is scope for commodity prices to fall to an extent that is greater than what is justified by a world economic slowdown.
The future is full of surprises. If I had to put forward an idea for how the next few years could turn out much better than most analysts (myself included) are forecasting, my leading candidate would be a large fall in commodity prices out of all proportion to any weakness in the world economy.
If that happens, then we would see a dramatic drop in inflation and a sharp recovery of consumer real incomes. This would help people to absorb the effects of the fiscal squeeze. It is certainly something to hope for. And it may just happen.
Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte
roger.bootle@capitaleconomics.com
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