Commodity Price Movements in the Twenty first Century

Commodity set Movements in the twenty sawhorse bill first CenturyCommodity exceedingly Cycles and BubblesSharp parkway in goodness determines, especi eachy of oil color colour, and some base all(a)oys want copper, since the turn of the century, subscribe attracted gigantic inter bailiwick attention and study. The price of oil, which shot up from the undisturbed levels of approximately twenty-eight USD per barrel, a a couple of(prenominal) old age ago, to the senior high school s reddenties, in 2006, sent ripples through the economies of advanced nations, even as it added zillions to the trus 2rthy nib surpluses of oil rich nations, same(p) Kuwait. bandage the causal agency in oil attracted international attention because of its universal usage, prices of items like copper, steel, cement and uranium similarly so bed to new heights.These developments direct to big interchange among sparing experts and business thinkers, who were carve up in their opinio n intimately the causes of goodness behavior, as intimately as its future movement. tour a large number of scholars feel that the y step uphful movement in goodness prices is no more than the initial movement of a wave that allow move for some more twenty-four hourss, if non decades, differents put it down to wrong scotch policies and the work of grocery speculators. This research assignment aims to field of operation and explore the versatile aspects of this extremely intriguing and globally significant development, and thus arrive at findings and conclusions that ar able to class the complex topic.Executive SummaryThis research assignment attempts to delve deeply into the causal factors behind the sharp upward movement in prices of commodities during the croak six age. The assignment is structured into sections that describe the station in totality, and indeed off up the umpteen theories that gravel gained ground in recent years on the issue. While umpteen people believe that a commodity ace daily round is chthonian way, powered by the regard for somatics from an enormously dissipated growing chinaw be, oppositewises feel that these movements, like the maven in the price of oil, is a twenty-first century reminder of the commodity spew place that in additionk the price of tulips to astronomical heights in seventeenth century Holland.The study includes an analysis of the commodity super roll, the roles played by the maturation of china and India in increasing commodity requisite, the effect of liberal m iodintary policies, and that of tough use, in the price movement process. Detai conduct analyses of the thoughts and writings of experts on the subject, including thinkers like Jim Rogers and financial professionals like Stephen Roach, a presbyopic with the study of texts and journals forthcoming on the subject, tolerate led to findings that be possessed of lent themselves to some interesting analyses a nd conclusions. These leave behind hopefully prove to be relevant in providing fresh perspectives, and growing available k right offledge on the issue.1. Introductiona. OverviewRecent years meet witnessed enormous changes in the global scotch scenario. Much of what is happening in the wipe continental market place owes its origin to the vision and determination of a slightly built and thrice married octogenarian, Deng Xiao Ping. Deng, the Chairman of the Peoples Republic in the 1980s, introduced broad and sweeping changes in the Chinese preservation under the name of the four modernisations. His reforms, which c all everywhereed agriculture, industry, science and technology, and the military, opened up the Chinese delivery, and were instrumental in transforming it into one of the largest and fastest growing economies of the human beings. (Deng Xiao Ping, 2007) years of double-digit stinting and infrastructural maturement in China profoundly affected the economies of oth er countries, and, in the process, set off a extensive tide of economic movement that encompassed the whole world. In the mid nineties, the socialist government of India, jeopardize by international debts, shrinking contrasted deepen reserves, and an exasperated population, unyielding to catch up with its larger neighbour, and initiated a series of economic reforms that led to sharp additions in economic development, and catapulted the unpolished into the ranks of the fastest growing world economies.The unharnessing of these both countries, which together account for a third of global population, from the shackles of responsibility economic control, has cr buryed an scarce demand for commodities. As China and India rush to come to up for decades of low growth, poor living standards, and abysmal poverty, their booming economies ar hungrily devouring ever-increasing quantities of metals, agricultural produce and oil products. This insatiable hunger, in the opinion of econo mists 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 bound to burst, and cover all connected with a good amount of unpleasant and possibly shameful debris.b. Definition of problemThe contemporary upward movement of commodity prices has fabricated worrying overtones. The escalating prices of crude oil, which moved up, in a item 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. Apart 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 amaze continental alkali. Price behaviours of different commodities are under detailed scrutiny, with experts stressful to pin down their grounds. While the sharp increase in the price of maize is attributed to the diversion 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 increase consumption in China and India. The huge boom in the Indian agate line market, on the other hand, appears to be due to the large influx of outside(prenominal) institutional investors, who have taken indices in the kick the bucket two years to more than twice that of 2005.While the enormous increase in economic activity has resulted in change magnitude profitability for business corporations, and has presumably contributed towards lessening of poverty and want, the accompanying ostentation has too brought with it enormous worries, particularly for governments of ontogeny countri es. Recent months have seen governments, (under tremendous pressure from angry citizens) and rally banks cram prime lending pass judgment, and use other economic tools to suck peculiar(a) money out of the system, in futile attempts to contain runaway pompousness. In the midst of numerous theories, the only constant appears to be in the movements of commodity prices, which move on to climb, of course with layoveric pauses, and occasional corrections. The development of a gigantic lasting commodity super cycle, in the opinion of many experts, appears to be the major(ip)(ip) causal factor behind the present circumstances. In this scenario, it becomes historic for economic thinkers to focus on the actual reasons for this phenomenon, and its likely consequences, in localise to take corrective fulfill.c. ObjectiveThis assignment delves deeply into the issues related to commodity life cycles, and commodity bubbles, from economic, political and social perspectives, and with parti cular 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 examination of primary and secondary training sources, and the study of available literature and research. It views substantial use of secondary material in the form of texts, journals and magazine articles as healthy as net income sources for purposes of data handiness, analysis and investigation. A good amount of thinking on the subject has occurred in the former(prenominal) few years with numerous experts expressing often quantify contradictory and quite confusing views in their syndicated and one-off columns.Despite serious and real effort, some important information regarding the topic may considerably have not found place in the assignment, a deficiency that could furbish up the validity of its conclusions. The bibliography provides complete details of the accessed informati on. The order of issues taken up for discussion is sequential, for the sake of logical progression of ideas and thought.2. Literature Reviewa. The Commodity extremely CycleEconomists have, for decades, believed in the theory of cyclical growth, characterised by periods of growth, followed by years of depression or slump. Events, economies, and political systems move through cycles similar to the native life cycles of living beings. These cycles, small-arm observable, have no obvious reason and involve changes between periods of comparatively swift increase of production, income and prosperity and periods of coitus stagnation. (Business Cycle, 2007) These periodic movements do not follow an established or anticipate pattern and behave randomly, with extended, or short, growth or slump years. In the clove pink and commodity markets, these boom and bust periods have been famous for do widespread prosperity or destruction. Cycles generally comprise of four manifest phases namely contr perform, trough, expansion, and peak. Whereas expansions and contractions account for the major portion of the cycle, the troughs and peaks denote the lower and focal ratio turning points where contractions change into expansions and vice versa. These cycles have been the focus of detailed economic study for ages with governments trying, nighly without success, to smoo consequently slumps, periods that have historically caused widespread unemployment, losses and suffering.Business cycles are as applicable to commodities as to other elements of the delivery and are generally measurable in movement of national or regional gross domestic 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 in the first place occur because of major economic developments that are significant enough to fuck off demand and consumption on a global basis for long periods. Super cyc les form because of the industrialisation or urbanisation of a major sparing, (Heap, 2005) a process that normally occurs over decades, and leads to situations wherein increases in supplies of commodities are otiose to catch up with increases in their demand. These imbalances, while originating in particular geographic 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 on that point clearly are long-term cycles and that they are driven by primal changes in the world most 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 high while producers struggle to increase the potentiality to meet that demand. Ultimately, prices peak when excess capacity has been developed 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 ground forces, during the turn of the nineteenth century, created a super cycle in commodities. Later, commodity super cycles developed during the post war reconstruction of Europe followed by enormous economic activity in lacquer.If you look at hi story, 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 millenary indicates that the global miserliness is in the midst of a strong commodity super cycle, a phase that has just about started and still has a l ong 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, atomic number 13, nickel, leadless 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 day at the moment and to the highest degree people forecast that it will have 125m barrels a day in the contiguous 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 $100 a barrel in the event of a publish shock a disruption to the interpret of oil as a result of nat ural disaster, sabotage, war or political upheaval. (Cooper, 2005)Copper has alike behaved in virtually the same manner from the lows it saw in 2001. directly its the turn of the grains, where wheat and particularly corn have set off higher on the US futures exchanges. (Guthrie, 2007) A number of other experts are reinforcing this phenomenon. While metals, led by base metals such as copper, aluminium and zinc, as well as precious metals like gold, silver and atomic number 78 have, until now, on with oil, led the price charge, prices of agricultural produce are also beginning to rocket. Recently however, commodity professionrs have doubled sugar prices to 24-year highs, and are contemptible into coffee and soybeans. (Dorsch, 2006) Prices of iron ore have risen to dizzying heights, a good deal 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 arti cles, twain prophesying its continuation for many more years or predicting a tramp back in the near future, pack the pages of financial journals and magazines. Each second base 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 current trend of increasing prices, across a cross section of fuel, metal and agricultural commodities should remain in place for quite some time.b. briny 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 c atapulted him into the ranks of those whose actions changed todays world. The performance of economic reforms accompanied with the opening of the Chinese economy resulted in unprecedented and unimaginable growth rank. During the last twenty-five years, the soils economy changed from a exchangely 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 incorporate innocuousdom from price control, fiscal decentralization, increased autonomy for state controlled enterprises, 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 GDP growth well in excess of 10 % and a tenfold increase in GDP since 1978. The solid ground, in recent years, has overtaken the most advanced nations of the world, and in hurt of purchasing power parity, 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 kwai /dollar exchange rate tholeged at 8.11 per dollar, undervalued by 30% to 40% on a trade-weighted basis. (Dorsch, 2006)Growth 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 importantly in the PRC, making it, in many ways, the worlds factory. The country has the largest current account surplus, nearly 180 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, intensity of use is now tercet times that of the USA, with demand driven by urbanisation, industrialisation and rigid 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 boilersuit growth in global consumption with growth in internal consumption. The International financial Fund heralds that its share of the overall growth in global consumption of industrial commodities between 2002 and 2005 was gigantic 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 elicit proportions.While China has been and should continue to be a major driver o f 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 country started opening up its economy from the mid nineties. Shackled for years under a bureaucratic mixed economy 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 diplomatic minister Manmohan Singh, wants his country to achieve 10% economic growth in the adjacent two to collar years, to create more jobs and help lift a third of the countrys 1.1 billion people out of poverty. Asias fourth-biggest economy expanded 8% in the second and third quarters 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, In adoptesia 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, a s 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 fortify the consumer super cycle.Terming Indias economic growth since 1991 phenomenal, World Bank President Paul Wolfowitz on Saturday said its GDP (gross domestic product) growth could be 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. precisely it needs 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 insurance policy model to the world. It showed continued development in nation 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. Wh ile 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. Central banks of most countries, Japan, Europe, China and India have followed super easy money 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 soak up foreign currency earned through foreign trade and direct investment into Chinese factories from abroad. Explosive money supply growt h, 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 conflagrated 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 markets 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 liquidity has enabled both Japanese and hedge fund traders to take up large speculative positions in global commodity markets. While fusty 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 gold supply in Eu rope 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 hitting significantly high levels is the underlying idolatry 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 jeopardise to destabilize the government) proved immune to three doses of interest rate hikes, 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 ta ke all the necessary monetary measures, further hikes in interest rates could come. But will airlift interest rates read 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 monetary 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 preference towards growth, to the exclusion of inflation. The undisciplined use of liberal monetary policies has contributed towards this present climate of inflation, and in strengthening the commodity su per cycle. The creation of shortages because of rapid and unexpected growth in consumption is a fait accompli, and a short-term discomfort economists are earn to bear, (in the interest of growth), until increased supply stabilizes the situation. In the absence of measured intervention, get rid of increase in prices, apart from inducing speculative activity, also attracts hordes of bona fide investors, big-ticket investment funds, pension funds, and even private retail investors. indemnity funds, as well as small, retail investors are looking to commodities as a crucial part of diversification of any investment portfolio. Although schizoid commodity day traders could decide to turn massive paper wage into hard cash at a moments notice, causing a 5% shakeout, the longer-term odds still favor 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 pe riods, 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 fasten or loosening 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.Whi le 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 two countries.We have China bosom capitalism. We have India embracing capitalism. Thats brought 2.2 billion people into play as very 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 parts 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 wh ereas 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 Sachs 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 look 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 growth 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 soon 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 pha ses 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 can last for as long as fifty to sixty years. Obviously, these longer waves comprise of a number of smaller 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 deal 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 arising to