Typically, commodity prices are broadly influenced by the business cycle. They generally rise when the economy is expanding and demand is relatively higher, and they generally fall when the economy is contracting and demand is relatively lower. But over the past several years, global trade wars, COVID, the war in Ukraine, central bank rate hikes, and exchange rate fluctuations have disrupted those patterns.
Global growth was 6.0 per cent in 2021. It is expected to be 3.2 per cent in 2022 and 2.7 per cent in 2023. Barring the global financial crisis and the severe phase of Covid -19 pandemic, this is the weakest growth profile since 2001.
Global inflation was 4.7 per cent in 2021. It is expected to balloon to 8.8 per cent in 2022 but to decline to 6.5 per cent in 2023 and to 4.1 per cent by 2024.
In response to the increasing inflationary trend, the central banks of many nations resorted to tightening of the monetary policy to restore price stability. The real interest rates have risen. Simultaneously, the fiscal policy is being directed by policy makers across the nations to alleviate the cost-of-living pressures while maintaining a sufficiently tight stance aligned with monetary policy.
However, the monetary and fiscal policy stance to arrest rising prices, may have deflationary implications.
Commodity prices had already been on the rise before Russia invaded Ukraine, as global supply disruptions and COVID broadly impacted markets.
During the last two years inflation has been mostly driven by commodity prices – especially energy – and persistent bottlenecks in supply chains, with roots in the insufficient investment since the global financial crisis. Inflation measures that exclude energy are considerably lower than consumer price inflation.
For the rest of the two quarters of calendar year 2022, the market sentiment turned negative in 3Q for most risk assets – notably commodities, which may result in short covering rallies, but the high price cure appears to be the predominant force at the start of 4Q.
The consumer price index rose 0.4% in October 2022 against expectation of .6%. Excluding volatile food and energy, core CPI increased 0.3% month-over-month after gaining 0.6% in September. CPI rose 7.7% in October on an annual basis, down from 8.2% the prior month, as headline inflation fell below 8% for the first time since February.
The global money supply has been taking a plunge and affecting the demand. Weakening demand risks lower inflation and even deflation. The deflation risk is much higher than the inflation risk.
However, the current outlook for both global growth and real interest rates suggests a downward path for commodity prices. The interest rate is a “cost of carrying” inventories. An increase in the interest rate reduces the demand for holding inventories and therefore lowers the commodity price.
Not all prices will fall. Different commodities tell different stories. The market price of natural gas in Europe is bound to rise further as the continent learns to manage winter without Russian supplies. But the trend will likely be downward elsewhere.
For an exhaustible resource, a rise in the interest rate increases the incentive to extract today and thus expand the available supply.
For “financialized” commodities, an increase in the interest rate encourages institutional investors to shift out of the commodities asset class and into Treasury bills.
For a commodity that is internationally traded, an increase in the domestic real interest rate causes a real appreciation of the domestic currency, which works to lower the domestic-currency price of the commodity.
(Disclaimer: The author is
National President, Commodity Participants Association of India (CPAI).
Recommendations, suggestions, views and opinions given by him are his own. These do not represent the views of Economic Times)