Wednesday, February 11, 2015

Economy: The De-Hyping Of Commodities

(Drivebycuriosity) - Commodity prices are under pressure. Oil prices dropped around 50% since last summer; natural gas, copper, wheat, corn, cotton and other commodities also got much cheaper. The S&P GSCI Index, a gauge for all commodity prices, lost around 40% recently. We are now witnessing the de-hyping of commodities.

The massive price drop set an end to a period of high & rising commodity prices which had started around 2003. Since begin of this century oil, metals, agriculture and other commodities have been hyped by Goldman Sachs and other banks. Banks & brokers proclaimed a super-cycle for commodities and predicted high prices for oil and other materials because of the rising demand from China and other emerging countries and alleged supply shortfalls (driveby).

Hedge funds and many other speculators followed this advice and bought massively futures, ETFs and other financial products which are related to commodity prices. These investments led to a financialization of commodities, meaning that oil, metal and agriculture prices are set on financial markets like stocks & bonds. The speculative purchases caused a commodity rally on the financial markets - a self-fulfilling prophecy. Rising prices attracted even more commodity speculators which lead to a snowball effect. For years commodity speculation looked like a oneway street.

The commodity hype of the recent years created bubbles, because commodity prices became a mirror of the behavior of the financial investors and lost the connection to the fundamentals. High commodity prices did what the always do, they animated the producers to produce more and prompted the consumers to consume less. In the US people invested into shale oil, worldwide miners drew more metal from the earth and farmer planted more crops, all driven by higher prices & profits. No we have an oil flood and an oversupply of many other commodities (supply). The dream of a super cycle came to an end.

I think that the price drops are a sign of the de-hyping of commodities. Many speculators are selling their financial investments in commodities and are re-transferring their money into stocks & bonds.


                                    Secular Trend Of Falling Commodity Prices

I also believe that we are back on the long term (secular) trend of falling commodity prices: The longest dataset publicly available (The Economist`s index of industrial commodity prices) shows, that "There has been a downward trend in real commodity prices of about 1 percent per year from 1862-1999 (jstor) (= commodity prices fell 1 per cent relative to the general price level).

As described above this trend has been temporary interrupted thanks to the hype induced by banks and brokers, who earn a lot money with trading futures and other commodity related financial instruments. I agree with scientists who claim that the dramatic price increases over the last decade were just a temporary blip up within the context of a longer-run trend of stable or declining relative prices"(econbrowser).

Why that? The shale oil revolution in the US explains why commodities get cheaper over the time. Technological progress and human ingenuity are reducing the cost of oil exploration and are enabling investors to tap reserves which have been to costly before. Farmers use more and more machines for planting & harvesting and benefit from improvements in irrigation, fertilizer, pesticides, and hybridization. And miners also use better machines and new technologies to prospect metals & coal.

I assume we re-entered a new era of (relatively) falling commodity prices driven by advances in technology and developments in engineering.

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