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Economics Weekly

Commodity prices unlikely to be affected by the credit crisis

Wed, Sep 26 2007, 07:05 GMT
by Trevor Williams

Lloyds TSB Financial Markets

Commodity prices are rising, despite credit concerns
Commodity prices seem to be holding up remarkably well to the crisis in the financial markets. Is this because it is only a matter of time before they get impacted, or because the financial problems are overstated insofar as they will affect economic growth or is it that growth in the emerging market economies is so strong that it can shrug off any slowdown in the developed economies? This may not be a question that can be answered without more time to assess the impact of the credit crisis on banks. However, the facts are that the global economy seems to be marching on and any credit market impact is being felt in the developed economies and not in the emerging markets, where the marginal rise in demand for commodities seems to be coming from. In our opinion, it is a combination of fast economic growth and a bigger share of commodity demand from the emerging economies that explains why the effect of the sub prime crisis will be small at a global level on prices. It is this fact that explains why commodity prices seems to be untroubled by the continuing turmoil in global credit markets. As a result, insofar as commodities are an asset class, there might even be a renewed flow of investment into the segment.

Uncertainty remains, but global growth is solid, led by the emerging economies…
Oil prices are at a record high in nominal terms and approaching the all time high reached in 1979/ 81 in real terms as well. Gold prices are above $720 an ounce; equity markets have shown a modest correction but no more than that, while government bond markets are seeing falling yields yet corporate spreads remain wide. What is going on? Part of the reason why oil prices are so high is that global growth remains strong, and, as chart a shows, the price of commodities and world economic growth are closely linked. But why, if growth in the developed economies is set to slow in 2008 (something, incidentally, that we do not believe is true for the US economy next year compared with 2007), is demand for commodities so strong?

The reason is strong demand growth from the emerging market economies, which is expected to persist. This fast growth has also meant a sharp fall in stock levels for a range of commodities, further fuelling price inflation. This is one reason why the rest of the world will not join the US in cutting interest rates and why long term bond yields rose in the US when short term rates were cut to 4.75% on 18th September, there is concern about future consumer price inflation from the pace of economic growth and higher commodity prices. Charts b, c and d show that economic growth is not just strong in the large economies of China, Brazil, India and Russia, but in a range of smaller emerging economies from every continent in the world and this is boosting the equity markets and exchange rates of these countries.

…and so commodities, which they are increasingly producing and using, are unaffected by the global credit squeeze
One example of why growth in the emerging markets is more significant for the world economy than in the past is that Chinese consumption of four out of the five most basic food, energy and industrial commodities now outstrips that of the US. Our charts illustrate this point more clearly, with production and consumption being dominated by the new emerging market economies. Charts e, f, g, h, i and j show that the biggest producers and consumers of commodities from metals used in production, to energy and food are a range of emerging market economies. It is this that makes it unlikely the world will suffer anything more than the mildest of slowdowns from the credit crisis, if at all. But it also means that price inflation is more of a threat to global economic stability than at any time perhaps in the last decade. This implies higher, not lower average interest rates going forward. As a financial market strategy, it also implies further flows into commodity type investment products.

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Published on  Wed, Sep 26 2007, 07:04 GMT

Archive

• High global inflation has hit economic growth
  Published On Tue, Sep 2 2008, 06:30 GMT
• Global 'real' interest rates are too low
  Published On Tue, Aug 26 2008, 11:20 GMT
• Oil price fall to boost global growth in 2009?
  Published On Tue, Aug 19 2008, 06:59 GMT
• Focus on BoE Inflation report and CPI inflation in UK & US
  Published On Mon, Aug 11 2008, 13:04 GMT
• Fed, ECB and BoE to hold interest rates on growth fears
  Published On Tue, Aug 5 2008, 07:56 GMT

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