Why commodity prices are surging – The Economist explains

The strong performance of the global economy finally has an impact

THE strong performance of the world’s economy is finally filtering into commodity prices. Last year will probably turn out to have been the first year since 2010 in which growth accelerated in each of America, Europe, China and Japan. And Brent crude oil, copper and a Bloomberg composite index of spot prices for 22 raw materials are all at their highest levels since November 2014. But if global demand has been picking up for several quarters, why has it taken this long to become evident in commodity prices? And more importantly, how sustainable is the rally?

The delay in the price increases is the easiest part to explain. Years of strong production of oil, base metals and grains left the global economy with huge surpluses. Stockpiles of oil reached a record high in November 2015, according to the International Energy Agency. OPEC, the oil cartel, agreed to restrain production in order to drain the surpluses and eventually put prices under upward pressure. China also applied the same principle to certain sectors. In 2016 it cut the number of working days for coal miners from 330 to 276, and halved its steel output to 65m tonnes. These measures appeared to have little effect at first, but now that strong demand has eaten into those reserves, prices are rising.

The rally’s likely length is trickier to assess. The short-term outlook for the global economy is highly encouraging. The American economy continues to create jobs at a rapid rate, and businesses there are confident about the probable impact of President Donald Trump’s tax cuts. European manufacturers are also buoyant. The Chinese economy proved so resilient to tighter credit conditions in 2017 that some of the those capacity cuts were reversed. Furthermore, other emerging markets that have struggled in recent years, notably Russia and Brazil, are growing again. It appears likely that the global economy will grow as quickly in 2018 as it did in 2017. This will generate higher demand for commodities.

But in the longer term, prices may weaken. After all, oil prices have only risen above $60/barrel thanks to OPEC’s emergency production-cutting measures. When the agreement ends at the end of the year, and the cartel’s members are again allowed to pump at will, supply will jump and prices will fall. And if OPEC’s strategy proves more successful than expected and prices continue to climb, then American shale producers will drill faster to exploit greater profitability. China can continue to unwind its capacity cuts or invest in new, greener production if prices become too hot. In agricultural markets, there are no cartels like OPEC to bring producers together to negotiate output cuts. Consequently, excellent recent harvests of the most widely consumed grains and seeds—wheat, maize, soybeans—have kept a lid on prices. And stocks are still bulging, so any price increases arising from freezing weather across North America at the beginning of 2018 will be temporary. Even after years of commodity producers limiting their output to support prices, they should be wary of loosening their belts too quickly.

Source: Why commodity prices are surging – The Economist explains

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