Increasing Price of Commodities Having Broad Ramifications
United States (Mar. 3, 2011) – What are the key drivers of the recent surge in commodity prices? Some say it is the weather, others blame speculation for driving up prices, and still others say we are entering into a “super-cycle” for commodities driven by strong demand from emerging markets.
Food and Energy Prices Rise Due to Structural Market Changes
Food and energy prices are widely expected to continue to rise due to structural changes in the world economy including lackluster production (which some blame on global climate change) and large increasing demand from developing nations with large and growing middle classes.
These fundamental structural changes portend higher prices for raw materials in the future.
Commodity Price Increases – Steadily Climbing
The uptick in commodity prices began in earnest in early 2009 as the global economy started to recover and grow from the financial meltdown, bailouts, etc.
At first it was only the business-sensitive products (e.g., industrial metals, energy) that started to climb in price and then some episodes of inclement weather damaging crops highlighted the vulnerability of the agricultural sector to lower production.
Lack of Incentive to Increase Supply Portends Continuing Commodity Price Increases
While the free market typically takes care of supply and demand imbalances eventually (e.g., by incentivizing increased supplies due to the potential profits), many analysts feel in the current market, for various reasons, prices will need to rise very sharply to provide sufficient incentive for increased supplies (e.g., much higher coffee prices encouraging farmers to plant more acreage with coffee).
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Some supply issues are related to a sharp cutback in capital spending during the economic downturn and subsequent credit crunch.
La Nina Continues To Threaten Supplies Causing Rise in Commodity Prices
Meanwhile a persistent La Nina weather pattern as has reeked havoc on crops in Central America and South America and supply disruptions occurred in various areas last year from the fire in Russia that drove up wheat prices to floods in Australia that harmed crops.
Many see a heightened volatility in the agricultural sector for years to come due to global climate change issues.
Surpluses Become Deficits as Prices Increase for Commodities in 2011
Most commodity markets had large surpluses in 2009 due to the sharp drop in demand caused by the worldwide recession. The surpluses began turning into deficits in 2010 as demand began outpacing production, and in 2011 supplies are growing increasingly tight.
If the global recovery continues it will sustain and/or increase high levels of demand for raw materials, particularly in emerging economies including Brazil, India, China and Russia.
Political Turmoil Doesn’t Bode Well for Commodity Prices
With oil hovering around $100 per barrel there remains much uncertainty in the energy sector. There has been little good news regarding expanding non-OPEC oil production while unrest and political turmoil in North Africa and the Middle East cause increasing concern.
Several OPEC countries could substantially increase production if they wish (e.g., they have “spare capacity”) and this could provide needed relief to the current strong upward pressure on oil prices.
However if this does not occur and if high oil prices persist it could hurt worldwide economic growth by reducing the disposable income of consumers, largely due to higher transportation and heating costs.
Inclement Weather and Export Bans Worsen Commodity Price Increases
The 2010-2011 harvest season is projected to bring lower production due to unfavorable weather. Droughts in the Black Sea Region and Russia began the rise in agricultural prices and the recent dry weather in South America and floods in Australia have exacerbated the situation.
Also worsening the food commodity supply problem have been export bans by producing countries at a time of rising worldwide demand.
The strong demand for agricultural products is expected to place pressure on supplies for at least the next couple years due not only to the increasing world population but also due to the populations of developing countries (emerging economies) eating more refined foods including meat products and drinking more specialty coffee of the Arabica varietals (e.g., Bourbon, Typica and Arabica).
Also competing for food product supplies is the biofuel industry. Meanwhile various crop diseases like wheat stem rust have also become an increasing problem along with global weather changes causing inclement weather.
Commodity Shortages Come at Time of Rising Demand
The theory of a super-cycle involves the belief that a shortage of raw materials at a time of rising demand from emerging markets is now going to drive a cycle that had been held off during the years of the economic downturn.
Most analysts now believe that a bull market in commodities will continue and even strengthen in the coming months. World reserves are being depleted and this will put more upward pressure on prices.
Easy Credit Growth May Be Stalled By Rising Commodity Prices
Some economists fear that rising commodity prices could stall the growth we are now seeing in world economies. The growth is being fueled by an “easy money” monetary policy along with pent-up consumer and business demand and very strong growth in foreign markets, and in particular Asia.
However the recent sharp rise price of oil along with other commodities has dampened economic forecasts for the coming year. Most economists expect the Fed to keep short-term interest rates very close to zero at least until the end of 2011 which should continue to help fuel growth.
Debt and Deficits Favor Bull Market on Commodities
A weak housing sector continues to cause concern as do worries about the U.S. government’s national debt and continual deficits and how they will be solved and how much these issues will devalue the U.S. dollar.
Most economic analysts these days have concluded that the bull market in commodities will remain well into 2011, perhaps into 2012, with little likelihood in any case of commodity prices dropping significantly.
In the case of oil the finite supply, the fact that no new major oil fields have been discovered in four decades, and political unrest in the Middle East are all contributing to significant upward pressure on prices that shows no signs of easing.
Sugar prices have gone up six-fold in the last few years yet still sugar prices are only about half of their all-time high. Expect commodities to continue at their high levels and likely increase in the coming year.
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