The Hindu Business Line : Commodity prices vulnerable

The world has changed. It used to be that, in a recession (or recession-like environment), commodity prices would fall. No longer. Even as the U S economy moves into negative growth territory, oil, gold, foodgrains (wheat, rice, corn, etc.) and metal prices are hitting new highs, defying conventional relationships predicting softening prices as the economy slows.

It is another headache and challenge for the Federal Reserve as it tries to engineer confidence and a recovery (out of the financial rubble from the housing collapse) by injecting liquidity and slashing interest rates.

Rising demand

Apparently, what has thrown a spanner into the works is the rising demand for everything from the newly-prospering China and India (Chindia). A vast consuming class has emerged in these economies.

Their middle class would probably equal in size almost the total population of the Western world. The commodity price rise is, therefore, rising demand-, not supply shortage-driven, say the experts.

The explanation is plausible, seeing the massive increase in Chindia’s vehicle population, construction and general spending and consumption patterns.

In fact, so confident is Mr Jim Rogers, the investment guru, of a continuing boom in commodities, that he advises investors to put their all in a commodity basket for the best returns.

But one’s guess is that it is not just burgeoning demand from emerging economies that is behind the commodity price boom.

In oil’s case, predictions of depleting reserves have kept prices on a roll and above $100 in the last few weeks – this despite evidence of flattening U S consumption and record inventories.

Gold is playing its traditional role of a safe haven in these turbulent times. It is only the prices of agris which have been boosted by rising consumption and low stocks.

Dollar impact

Interestingly, rising commodity prices are also being linked to the plunging fortunes of the US dollar. As the Fed embarked on its rate-cutting spree, the greenback has touched new lows against practically every major currency.

Since the dollar is still the biggest medium of exchange in global trade, its fall has translated into higher commodity prices – so much so that in recent weeks there is an almost perfect correlation between the dollar on the one hand, and oil and gold prices on the other. The market has completely ignored the implications of the rapid US downturn.

Are commodities the latest bubble, ask market watchers of their unabated price rise, drawing parallels to the now expired dot com and housing bubbles.

While the rising demand of the newly-industrialising economies is no doubt a significant price positive, strong supply and technology responses in energy and agris are already under way.

And gradually diminishing risk and risk perceptions about the global economy and financial markets will be negative for gold.

A sudden collapse or gradual fading away of commodity prices would be no surprise.

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