It seems like only yesterday that analysts were stroking their chins and telling us in all-knowing tones that the global supply of commodities could not keep up with global demand. Man’s ability to feed a growing population was being challenged once again.
In discussing these insurmountable obstacles, analysts would throw out “China” and “India” to explain how a billion people here and a billion there were starting to add up to a lot more mouths to feed and gas tanks to fill—now that India’s Tata Motors Ltd is introducing the Nano, or the people’s car, for $2,500 (about Rs1 lakh).
Of course, China and India didn’t just emerge as global consumers in 2008, which is when commodity markets really got nutty. The price of crude oil rose more than 50% from the end of 2007 to the July record of $147.27. It has fallen 21% since then. Even the outbreak of hostilities between oil producing Russia and former Soviet Republic Georgia on Friday failed to interrupt oil’s slide.
Prices of corn, wheat and rice—yes, rice! that cheap, out-of-the-box starchy meal extender—went berserk this year. The neo-Malthusians came out of the closet, joined by their close cousins, the peak oil enthusiasts.
“I half expected to see corn shooting up from the terraces of Manhattan,” says Michael Aronstein, president of Marketfield Asset Management in New York.
Imagine my surprise when I learnt last week that the drop in commodity prices is a reflection of slowing economic growth worldwide, which is sapping demand for raw materials. It was as if I had slept through a couple of Ice Ages and awoke to find a prowling bear. Either that, or someone pressed a button and global demand went into reverse.
Oil into plough horses
“We have to invent a rationale,” says Aronstein, who thinks the seven-year bull market in commodities is over, not taking a breather.
He thinks the real price of oil should be the equivalent of the real price of plough horses.
“The crux of the matter is, can we replace a 100-year-old technology—the internal combustion engine—that has way outlived its place in the world?” Aronstein says. “There are hordes of people with 140-plus IQs working on this. It’s absurd to be against it.”
No sooner had weak demand replaced strong demand as the explanation for the move in commodity prices than the usual nonsensical analysis started to filter out. One widely held view holds that the decline in energy, food and metals prices—a result of weak demand—is going to stimulate stronger demand.
I call this the loop-de-loop school of economic analysis. It doesn’t seem to matter if the thinking is consistent with the most basic law of microeconomics: the law of supply and demand.
If weak demand (for physical commodities, or for investment and speculative purposes) is sending prices down, a situation represented by a shift-back in the demand curve, how are lower prices going to goose demand?
It would be one thing if lower prices were a result of a shift outward, to the right, in the supply curve. Then the equilibrium price would reflect the increased quantity demanded at successively lower prices, which is expressed by a downward sloping demand curve.
In this case, we’re not shifting the supply curve, Toto. How many times have we been told that energy supply is inelastic in the short run and constrained in the long run?
The reason prices are falling ostensibly is because producers and consumers are demanding less at any given price than they were before. A shift-back in the demand curve suggests a lower price and lower, not higher, quantity demanded.
Barrels and bushels
This principle is so basic it’s hard to fathom the widespread confusion. It comes from both people who don’t know any better and PhDs who should. And it never changes from one business cycle to the next.
During the first half of the year, the surge in commodity prices led to accusations of speculation and market manipulation. The US Congress got into the act, holding dozens of hearings on the subject.
Last month, senators Joe Lieberman, Susan Collins and Maria Cantwell introduced the Commodity Speculation Reform Act of 2008, which, among other things, closes the loophole allowing some commodity investors to evade the position limits set by the Commodities Futures Trading Commission. Some of the more onerous measures under consideration, such as banning pension funds from investing in commodities, were dropped.
The fate of the legislation is uncertain. Congress may return from its summer recess to find an entirely different commodities backdrop. And pension funds could end up with overpriced bushels instead of bonuses.
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