Non-energy commodity markets

Written by Stephen Poloz

Energy prices have been getting most of the attention recently, for obvious reasons. But many other commodity prices have been setting records, too, putting a tight squeeze on manufacturers.

Resource prices are generally correlated with the global economic cycle. As 2005 began, there was every reason to expect world economic growth to moderate from what we had seen in 2004. Indeed, because global growth was so rapid in 2004, it was clear that a repeat year in 2005 would be too dangerous, and central banks would make certain that the world economy would slow.

A moderation is apparent in many economies. The U.S. economy has slowed by around a percentage point, Europe is slower, Japan is slower. The rest of Asia appears to be moderating, too, although there is little evidence yet of a slowdown in China. Nevertheless, leading economic indicators have rolled over, bond yields have remained low, and the Australian dollar has been easing, all suggesting that more moderate, yet still solid, world economic growth is emerging.

In such circumstances it would be expected that world resource prices would plateau, and probably ease a little from their peaks as new supplies come on stream. And it is true, in aggregate. EDC’s non-energy commodity price index is well below its peak of August 2004. But most of that moderation is coming from forestry and agricultural commodities — most of the metals, which are generally quite sensitive to the economic cycle, have continued to move higher. Copper and zinc are both more than 40% higher than a year ago, while nickel and aluminum are more than 10% higher. Steel prices are the exception — they are well below year-ago levels.

One possible explanation is that we are not expecting a major growth slowdown, but more of a plateau, that will leave the demand for metals at a high level. With economic growth in the grey zone — slower but solid — metal prices will depend mostly on a supply response, which can vary by product. For example, steel production rose strongly last year, leading to softer prices. Copper mining output has risen substantially, too, but refining has been slower to catch up, leaving the market tight. This balance looks set to shift in a big way during 2006, as some major increases in copper refining capacity are being developed in India, China, Thailand, and others.

Another possible explanation is that the mix of world economic growth will continue to favour strong metal consumption. If the moderation is mostly in service-oriented economies such as the U.S., and less in goods-oriented economies like China, this could be the case. This explanation can only go so far, however, as much of China’s output is still consumed by richer countries.

The bottom line? So far, at least, the world economy appears to have moved into the grey zone of slower but solid growth, rather than seeing a major slowdown. That, combined with supply lags and a good dollop of speculation, is keeping metal prices strong. Such a combination could pose the risk of a precipitous drop in prices when new supply does hit the marketplace.

September 8, 2005

The views expressed here are those of the author, and not necessarily of Export Development Canada.

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