Commodity Price Movements in the Twenty first Century

goodness Price Movements in the Twenty first CenturyCommodity Super Cycles and BubblesSharp straw man in trade good monetary values, especi in ally of oil, and slightly base metals exchangeable copper, since the turn of the century, consecrate attracted enormous international at xtion and debate. The price of oil, which shot up from the sedate levels of approximately twenty-eight USD per barrel, a hardly a(prenominal) years ago, to the high s crimsonties, in 2006, sent ripples through the economies of advanced nations, even as it added billions to the current account surpluses of oil rich nations, worry Kuwait. art object the movement in oil attracted international attention because of its universal usage, prices of items like copper, steel, cement and uranium also soared to new heights.These developments led to intense discussion among stinting experts and tune thinkers, who were divided in their opinion intimately the causes of trade good behaviour, as head as its fut ure movement. opus a large number of scholars feel that the youthful movement in good prices is no more than the initial movement of a wave that will last for galore(postnominal) more years, if not decades, others regurgitate it down to wrong frugal policies and the work of market speculators. This research assignment aims to study and explore the various aspects of this extremely intriguing and globally signifi throw outt development, and therefore arrive at findings and conclusions that are able to illuminate the complex topic.Executive SummaryThis research assignment attempts to delve deeply into the causal factors behind the needlelike upward movement in prices of commodities during the last six years. The assignment is structured into sections that describe the situation in fallity, and then dish out up the many theories that declare gained ground in recent years on the issue. bandage many people believe that a commodity ace rack is nether way, ply by the deman d for materials from an enormously fast working chinaware, others feel that these movements, like the one in the price of oil, is a twenty-first century reminder of the commodity bubble that took the price of tulips to astronomical heights in seven aboutteenth century Holland.The study includes an analysis of the commodity super cycle, the roles played by the fruit of mainland china and India in increasing commodity demand, the effect of liberal monetary policies, and that of speculative action at law, in the price movement process. Detailed analyses of the thoughts and writings of experts on the subject, including thinkers like Jim Rogers and pecuniary professionals like Stephen Roach, along with the study of texts and journals available on the subject, swal misfortunate led to findings that invite lent themselves to some interesting analyses and conclusions. These will hopefully prove to be relevant in providing fresh perspectives, and increase available knowledge on the issue.1. Introductiona. OverviewRecent years dupe witnessed enormous changes in the global scotch scenario. Much of what is happening in the cross Continental market place owes its origin to the vision and determination of a slightly built and thrice matrimonial octogenarian, Deng Xiao Ping. Deng, the Chairman of the Peoples Republic in the 1980s, introduced broad and sweeping changes in the Chinese deliverance under the name of the four modernisations. His reforms, which c overed agriculture, industry, apprehension and technology, and the military, opened up the Chinese economy, and were instrumental in transforming it into one of the largest and fastest growing economies of the world. (Deng Xiao Ping, 2007) Years of double-digit economic and infrastructural issue in China profoundly modify the economies of other countries, and, in the process, set transfer a coarse tide of economic movement that encompassed the whole world. In the mid nineties, the socialist government o f India, endanger by international debts, shrinking foreign shift reserves, and an exasperated population, decided to catch up with its larger neighbour, and initiated a series of economic reforms that led to cunning increases in economic development, and catapulted the country into the ranks of the fastest growing world economies.The unharnessing of these twain countries, which together account for a terce of global population, from the shackles of state economic control, has created an extraordinary demand for commodities. As China and India rush to make up for decades of low gain, poor living standards, and abysmal poverty, their manna from heavening economies are hungrily devouring ever-increasing quantities of metals, awkward produce and oil products. This insatiable hunger, in the opinion of economists and market analysts, has led to the development of a sustained increase in prices of commodities, known in economic parlance as a commodity super cycle. Other thinkers and columnists have expressed dissenting views, blaming market speculators for building up prices to unrealistic levels and creating artificial bubbles which were hold to burst, and cover all connected with a good tot up of unpleasant and possibly disastrous debris.b. Definition of problemThe current upward movement of commodity prices has assumed worrying overtones. The escalating prices of crude oil, which moved up, in a period of a few years, from the regions of the mid twenties per barrel, to that of the high seventies, perplexed and worried governments, and economic thinkers all over the world. obscure from oil, prices of many commodities, particularly metals and agricultural produce, have escalated to unprecedented levels, impacting price indices, affecting buying power, and unsettling economies on a cross continental basis. Price behaviours of different commodities are under enlarge scrutiny, with experts trying to pin down their reasons. While the sharp increase in the p rice of maize is attributed to the warp of corn for production of bioethanol for the US and Brazilian markets, (Trade aspects of Biofuels, 2007) the increase in prices of oil is thought to be due to its increased phthisis in China and India. The huge boom in the Indian stock market, on the other hand, appears to be due to the large influx of foreign institutional investors, who have taken indices in the last two years to more than twice that of 2005.While the enormous increase in economic activity has resulted in increased profitability for business concern corporations, and has presumably contributed towards reduction of poverty and want, the accompanying inflation has also brought with it enormous worries, particularly for governments of developing countries. Recent months have seen governments, (under tremendous pressure from angry citizens) and key banks raise prime lending rank, and use other economic tools to suck extra capital out of the system, in futile attempts to con tain runaway inflation. In the midst of many theories, the only constant appears to be in the movements of commodity prices, which continue to climb, of course with periodic pauses, and occasional corrections. The development of a long immutable commodity super cycle, in the opinion of many experts, appears to be the major causal factor behind the present circumstances. In this scenario, it becomes important for economic thinkers to revolve around on the actual reasons for this phenomenon, and its likely consequences, in order to take corrective action.c. ObjectiveThis assignment delves deeply into the issues related to commodity life cycles, and commodity bubbles, from economic, polity-making and social perspectives, and with particular reference to the current global economic scenario. The subject matter is enormous and covers local and international developments in politics, society and economics. The assignment involves exam of primary and atomic number 16ary information sources, and the study of available literature and research. It makes substantial use of secondary material in the form of texts, journals and magazine articles as well as internet sources for purposes of data availability, analysis and investigation. A good amount of thinking on the subject has occurred in the olden few years with numerous experts expressing frequently contradictory and sort of confusing views in their syndicated and one-off columns.Despite serious and sincere effort, some important information regarding the topic may well have not found place in the assignment, a deficiency that could limit the validity of its conclusions. The bibliography provides complete details of the accessed information. The order of issues taken up for discussion is sequential, for the pursuit of logical progression of ideas and thought.2. Literature Reviewa. The Commodity Super CycleEconomists have, for decades, believed in the theory of cyclical emergence, characterised by periods of growth, followed by years of depression or slump. Events, economies, and political systems move through cycles similar to the natural life cycles of living beings. These cycles, while observable, have no obvious reason and involve changes between periods of relatively swift increase of production, income and prosperity and periods of relative stagnation. (Business Cycle, 2007) These periodic movements do not follow an established or expected pattern and behave randomly, with broad, or short, growth or slump years. In the stock and commodity markets, these boom and bust periods have been famous for causing widespread prosperity or destruction. Cycles generally lay out of four distinct phases namely contraction, trough, expansion, and peak. Whereas expansions and contractions account for the major portion of the cycle, the troughs and peaks denote the lower and upper turning points where contractions change into expansions and vice versa. These cycles have been the focus of detaile d economic study for ages with governments trying, mostly without success, to smoothen slumps, periods that have historically caused widespread unemployment, losses and suffering.Business cycles are as applicable to commodities as to other elements of the economy and are generally measurable in movement of national or regional gross internal product. Occasionally, commodities move into a phase of upward movement in prices for extended periods, which continue for many years, sometimes even many decades. They mainly occur because of major economic developments that are significant enough to drive demand and consumption on a global basis for long periods. Super cycles form because of the industrialisation or urbanisation of a major economy, (Heap, 2005) a process that ordinarily occurs over decades, and leads to situations wherein increases in supplies of commodities are unable to catch up with increases in their demand. These imbalances, while originating in particular geographical areas, occur for years and result in substantial price increases of commodities, and that too on a global basis, for extended periods.What we can say is that there clearly are long-term cycles and that they are operate by fundamental changes in the world around us. Global wars, the industrial revolution, major innovations in transport and communications are just some of the factors that can instigate long-lasting shifts in economic growth, that in turn stimulate demand for commodities. Increased demand drives prices higher(prenominal) while producers struggle to increase the substance to meet that demand. Ultimately, prices peak when excess capacity has been unquestionable the cycle is then completed when demand abates and general surpluses force prices lower. (Guthrie, 2007)Two discernible super cycles have occurred during the last 150 years. (Heap, 2005) Huge economic and infrastructural growth in the USA, during the turn of the nineteenth century, created a super cycle in com modities. Later, commodity super cycles developed during the post war reconstruction of Europe followed by enormous economic activity in Japan.If you look at history, there have always been super cycles in demand for commodities. There was a super- cycle during the British industrial revolution, during Americas huge period of growth before and after the second world war and during Japans industrialisation in the 1970s. (Cooper, 2005)Many economists feel that the movement of commodity prices since the turn of the millennium indicates that the global economy is in the midst of a strong commodity super cycle, a phase that has just about started and still has a long way to go. Gary Dorsch, writing for SafeHaven (2006) states that the Reuters Jefferies Commodity Price Index (CRB), which comprises of futures in live cattle, cotton, soybeans, sugar, frozen concentrated orange juice, wheat, cocoa, corn, gold, aluminium, nickel, unleaded gasoline, crude oil, natural gas, heating oil, coffee, silver, copper and lean hogs has reached levels 91 % higher than what it was four years ago, its highest level in 26 years. Apart from the behaviour of the CRB index, prices of oil have increased seven times from its 1999 levels.Demand for oil is about 85m barrels a solar day at the moment and most people forecast that it will hit 125m barrels a day in the following(a) 15 to 20 years. I see no way in which this will be met, so oil prices will stay high. Goldman Sachs, the investment bank, has even forecast that the oil price could hit $ cytosine a barrel in the event of a go forth shock a disruption to the confer of oil as a result of natural disaster, sabotage, war or political upheaval. (Cooper, 2005)Copper has also behaved in virtually the same manner from the lows it truism in 2001. Now its the turn of the grains, where wheat and particularly corn have exploded higher on the US futures exchanges. (Guthrie, 2007) A number of other experts are reinforcing this phenomenon. W hile metals, led by base metals such as copper, aluminium and zinc, as well as precious metals like gold, silver and platinum have, until now, along with oil, led the price charge, prices of agricultural produce are also beginning to rocket. Recently up to now, commodity traders have multiply sugar prices to 24-year highs, and are abject into coffee and soybeans. (Dorsch, 2006) Prices of iron ore have risen to dizzying heights, practically 72 % in 2005.While tracking of commodity prices is an ongoing activity, the frenetic movement of prices during the last seven years has added another dimension to the issue. Numerous articles, either prophesying its continuation for many more years or predicting a roll back in the secretive future, pack the pages of financial journals and magazines. Each minute movement in commodity prices is subjected to detailed scrutiny, compared with trends and used as a base for future forecasts. The majority however appears to be in consensus that the c urrent trend of increasing prices, across a cross section of fuel, metal and agricultural commodities should remain in place for quite some time.b. Main Causes behind Current and Expected Price Behaviour in CommoditiesWhile numerous major and minor reasons affect commodity price behaviour, this discussion focuses on a few major reasons, widely accepted to be the primary causal factors behind the constant and significant price increases of the past few years.The liberalisation process kick started by Deng Xiao Ping, in China, in the early eighties, led to developments that were possibly beyond his wildest expectations, and catapulted him into the ranks of those whose actions changed todays world. The implementation of economic reforms accompanied with the opening of the Chinese economy resulted in unprecedented and unimaginable growth rates. During the last twenty-five years, the countrys economy changed from a rallyly administered system, largely closed to international trade, to a market oriented economy with a rapidly growing private sector. Reforms, which commenced with the phasing out of collective farming, expanded to unified freedom from price control, fiscal decentralization, increased autonomy for state controlled first steps, a large and diverse banking infrastructure, vibrant stock markets, the growth of privately owned and controlled enterprise and the opening of the economy to trade and investment. As China implemented the reforms in a phased manner, the restructuring and consequent efficiencies led to a year on year gross interior(prenominal) product growth well in excess of 10 % and a tenfold increase in GDP since 1978. The country, in recent years, has overtaken the most advanced nations of the world, and in terms of purchasing power likeness, stands second only to the United States.Exports are a key driver behind the Chinese economic miracle, with Chinas currency exchange controls and trade surplus with the US topping $204 billion in 2005, a 25% increase on the previous year and nearly 30% of the total US deficit. The lynchpin of Chinese exports is the low Yuan /dollar exchange rate pegged at 8.11 per dollar, undervalued by 30% to 40% on a trade-weighted basis. (Dorsch, 2006) addition has also driven enormous spending on infrastructure and urbanisation, with millions of Chinese relocating from villages to urban centres. Foreign investors, from the west, as well as from East Asian economies like Japan and South Korea have invested significantly in the PRC, making it, in many ways, the worlds factory. The country has the largest current account surplus, nearly one hundred eighty billion USD, in the world. (CIA Factbook, 2007)This phenomenal economic and industrial growth, involving a ten-fold increase in GDP, has made the country a huge commodity consumer. In China, military posture of use is now three times that of the USA, with demand driven by urbanisation, industrialisation and fixed capital formation. (Heap, 2005 ) The Chinese miracle, with its huge demand for commodities has affected commodity prices profoundly in the past few years. As Chinas economy expands, it is sucking in raw materials to build up its infrastructure, including roads, power move and factories. (Cooper, 2005) This demand led to the country picking up a huge share of the overall growth in global consumption with growth in internal consumption. The International Monetary Fund reports that its share of the overall growth in global consumption of industrial commodities between 2002 and 2005 was massive 51% for copper, 48% for aluminium, 110% for lead, 87% for nickel, 54% for steel, 86% for tin, 113% for zinc, and 30% for crude oil. (Guthrie, 2007) The country now accounts 12 % of global industrial production, compared to 6 % in 1995, 4 % of GDP on an exchange rate basis and 13 % on a purchasing power parity basis. Appendix A provides details about Chinas demand for various metals.The constantly increasing demand from China , despite regular predictions of slowdown, has served to propel commodity prices year after year. While these price surges have had their periods of relative stagnation, as well as corrections, the demand shows no sign of abating and should grow for many more years. The per capita consumption of beef, for example, in China is 12 pounds per person, compared to 100 pounds per person, in western countries. As perceptions change and the possibility of the country catching up in the prosperity scales with advanced nations becomes a reality, the projected increase in demand assumes overwhelming proportions.While China has been and should continue to be a major driver of commodity prices for many more years to come, other factors have also contributed towards price movement and their effect may well increase in future. India, the worlds second largest country and its largest democracy started opening up its economy from the mid nineties. Shackled for years under a bureaucratic mixed econom y regime that favoured the public sector, the country suffered from an abysmally slow growth rate for practically fifty years since it achieved independence in 1947. The opening up of the economy, and the introduction of economic reforms, while slower in implementation than Chinas, (due primarily to the democratic and debate oriented nature of Indian society), nevertheless picked up steam by the end of the millennium, and entered an era of high growth in the early years of the present decade. The country is today, after China, the second fastest growing economy in the world, and is achieving growth rates of nearly 9 %. While both industry and services are growing at rates much faster than 10 %, agricultural growth has been comparatively slower.Indias Prime see Manmohan Singh, wants his country to achieve 10% economic growth in the next two to three years, to create more jobs and help lift a third of the countrys 1.1 billion people out of poverty. Asias fourth-biggest economy expand ed 8% in the second and third forces of 2005. Singhs government wants industrial production, which makes up a quarter of Indias economy, to grow 10% annually to boost the incomes of Indians, one in three of whom live on less than $1 a day. Indias industrial production grew at an annualized 8.3% rate between April and November 2005, faster than major economies like US, UK, the Euro zone, Japan, Brazil, Indonesia and Russia. Only China and Argentina recorded faster industrial production rates of 16.6%, and 9.6% respectively. (Dorsch, 2006)In India, domestic demand makes up practically 70 % of the national GDP and dominates the economy, as opposed to exports, in many other nations. Indian imports, though lesser than that of China, doubled in the last three years, adding to commodity demand and strengthening the consumer super cycle.Terming Indias economic growth since 1991 phenomenal, World Bank President Paul Wolfowitz on Saturday tell its GDP (gross domestic product) growth could b e pushed up by one to two per cent with speedy reforms. He said The dynamism shown by India in the last 15 years is phenomenal. India can do better A couple of percentage more growth can be possible. But it involve sound fiscal and monetary policies. Continuity of reforms was important for the high growth, evident in the last 15 years. Indias incredible growth story was a policy model to the world. It showed continued development in democracy and open society. (Indias growth story, 2005)Apart from India, the two other BRIC countries, Brazil and Russia, are also growing strongly, strengthening the demand for major commodities. While the sharp spurt in growth shown by Japan in recent years has also fuelled demand, the growth generated by the BRIC countries, as well as economies of countries like Argentina and South Africa should continue for many years, even for some decades, as these countries try to achieve parity with the advanced nations.Monetary policies followed by the central banks of most countries have also played a significant role in fuelling commodity price increases. key banks of most countries, Japan, Europe, China and India have followed super easy silver policies from the beginning of the millennium right upto the last quarter of 2006 and this along with the demand from the Chinese and Indian economies have worked towards pushing prices up to record levels.The Peoples Bank of China increased its M2 money supply by 18.3% last year, issuing more Yuan to pick off up foreign currency earned through foreign trade and direct investment into Chinese factories from abroad. Explosive money supply growth, in turn, boosted domestic retail sales by 13% last year, and industrial production was 16.6% higher in November from a year earlier. Chinas central bank raised its M2 money supply target to 17% in the third quarter from 15% earlier, to offset stronger demand for the Yuan, and maintain the peg at 8.11 per US dollar. (Guthrie, 2007)In Japan, money mark ets have received trillions of yen, more than required by local Japanese banks, pushing interest rates on deposits to levels even below zero. This enormous amount of excess and free liquid has enabled both Japanese and hedge fund traders to take up large speculative positions in global commodity markets. While conservative counsel advocates a stricter monetary policy, authorities are reluctant to make changes in a policy that has seen overnight lending rates staying at zero for nearly five years.In Europe, loose money availability has also helped in fuelling inflation and price instability. The growth rate of M3 Money supply in Europe in Europe has become considerably higher than the previous year, and helped in lifting stock markets to higher levels. All over the world, bankers have seen commodity indices running away but refrained from taking action lest growth rates get hurt. Another factor that hinders bureaucrats from taking action after inflation starts contact significantly high levels is the underlying fear of small course-corrective measures not working and the risk of dampening growth. If a central bank stops excess liquidity too late it has to raise rates much more strongly and that causes turbulence on the markets. (Guthrie, 2007) Indian policy makers, found to their chagrin, that inflation growth rates that had crossed 6.5 % (and were threatening to destabilize the government) proved immune to three doses of interest rate encouragements, by 50 basis points each time.A sharp hike in borrowing and lending rates took place in recent weeks. With inflation up at 6.4 per cent and the RBI saying it will take all the necessary monetary measures, further hikes in interest rates could come. But will raising interest rates bring inflation under control? Does India have the markets and institutional framework in which raising interest rates is an effective instrument for inflation control? Does India have a central bank that has learned how to conduct mone tary policy in an open market economy? The answer to these questions is No. In this sphere, India lags behind modern practices. (Patnaik, 2007)While lack of faith in the measures taken by ones own government appears to be a generic trait with analysts all over the world, sustained increases in commodity prices have led to a consensus that economic and monetary policies, followed all over the world, have been unbalanced in their blind perceptiveness towards growth, to the exclusion of inflation. The get rid of use of liberal monetary policies has contributed towards this present climate of inflation, and in strengthening the commodity super cycle. The creation of shortages because of rapid and unexpected growth in consumption is a fait accompli, and a short-term discomfort economists are ready to bear, (in the interest of growth), until increased supply stabilizes the situation. In the absence of measured intervention, unbridled increase in prices, apart from inducing speculative a ctivity, also attracts hordes of genuine investors, big-ticket investment funds, pension funds, and even person retail investors.Pension funds, as well as small, retail investors are looking to commodities as a crucial part of diversification of any investment portfolio. Although schizophrenic commodity day traders could decide to turn massive paper profits into hard cash at a moments notice, causing a 5% shakeout, the longer-term odds still estimation a continuation of the Commodity Super (Guthrie, 2007)c. The Future of the Present Inflationary MovementCommodity super cycles, by their nature and their reasons of origin, run for extended periods, for many years and some times for decades. Modern day literature refers to just two or three super cycle in the last two centuries, one caused by American industrial growth at the beginning of the twentieth century, and the other caused by post war reconstruction in Europe, followed by intense Japanese economic activity. The second super cycle lasted for nearly three decades from the late forties until the depression of the eighties. The current super cycle, if at all it is one, has gained momentum only during the last six years, and prima facie still has a long way to go. While monetary policies of powerful and rich individual nations, like the USA and Japan, as well as regional groupings, like Europe, will be able to influence commodity prices through tightening or liberalisation money supply, the extent of the commodity super cycle will depend primarily upon the growth stories being played out in China and India, and to some extent in the other two countries, Brazil and Russia.While China and India are both on the fast track to economic prosperity, they remain countries with low per capita incomes and consumption. The desire to achieve economic prosperity, in these economies, will not be satisfied with achievement of national GDP targets but will continue until individual aspirations of people are met in these t wo countries.We have China embracing capitalism. We have India embracing capitalism. Thats brought 2.2 billion people into play as really(prenominal) ambitious earners, who aspire to middle class status. If we take Asia, there are 3.5 billion people who aspire to the same middle class lifestyle many of us in the West take for granted. If we look further beyond Asia, this same phenomenon is evident with many other developing countries. We see it in separate of the Middle East with the Dubai city-state as an example. (Finch, 2006)Two simple examples will serve to elaborate this argument. As stated earlier, per capita consumption of beef in China is 12 pounds per person whereas it is more than 100 pounds per person in the advanced countries. Similarly, in India, where the majority of the people do not eat beef, and around fifty percent are vegetarian, the per capita consumption of chicken is around 12 pounds compared to more than 200 pounds in the west. A recent report by Goldman Sac hs states that even if, as predicted, both these countries reach the GDP levels of the USA by 2050, their per capita income will not exceed half that of the USA. This gives rise to two inferences, (a) the huge amount of latent demand in these countries and (b) the extended period over which these growth stories will possibly play out.Indias Prime Minister Manmohan Singh, wants his country to achieve 10% economic growth in the next two to three years, to create more jobs and help lift a third of the countrys 1.1 billion people out of poverty. Singhs government wants industrial production, which makes up a quarter of Indias economy, to grow 10% annually to boost the incomes of Indians, one in three of whom live on less than $1 a day. (Dorsch, 2006)Apart from the enormous potential for prolonged economic and industrial growth that can occur because of progress in these two countries, the fact that India is moving roughly ten years behind China, could lead to a situation where Indias gr owth rates start improving further when Chinas starts tapering off thus extending the period of the cycle.Climbing markets are prone to periods of lulls, stagnation and even correction. Experts feel that these phenomena are bound to continue to happen, but the demand for commodities will grow at such an overwhelming pace, not just in China and India, but also in other countries of the developing world that it will before long reassert itself and bring back bullish behaviour. While there is intense speculation in academic circles about the probable period of the inflationary run, very few people are ready to take a bet on its probable date of demise. Economists are quite sure of phases of economic activity where waves of activity and growth follow periods of slowdown and even stagnation. The problem arises when quantification is called for. In the past Dewey and Dakin in their book Cycles The Science of Prediction (1947) that a super cycle that moves from trough to peak to trough ca n last for as long as fifty to sixty years. Obviously, these longer waves comprise of a number of small waves, where activity increases and decreases in finite periodsEven as convinced a believer in the commodity bull cycle as Jim Rogers points out that the shortest boom lasted 15 years, while the longest lasted 23 years. His conclusion is that we have much further to go, but dont expect a great cut through more precision than that. Oh, and dont forget that well endure some huge corrections along the way. (Guthrie, 2007)Much of the current discussion on commodity super cycles owes its initiation to