While the global economy has been slowing and equity markets have reflected that, commodity markets have remained remarkably resilient. Since 26 July, when the recent slide in the stock markets started, the Thomson Reuters/Jefferies CRB commodity index has fallen a mere 3.7% (till 6 September). The price of Brent crude went down by 4.6% during the same period. Contrast that with the fall in the MSCI Asia ex-Japan index, which fell 14.9% over the period. The Asia ex-Japan region contains both China and India, the fastest growing large emerging economies; so any slowdown there should be reflected in the price of commodities. Trouble is, it isn’t. The chart alongside shows the relation between the CRB index and the Sensex during the recent market weakness, between 26 July and 6 September.

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Graphic by Sandeep Bhatnagar/Mint

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Since most commodities are traded in US dollars, a rise in the dollar index often leads to lower commodity prices. But during the recent market downturn, the dollar index went up from 73.4 on 26 July to 75.9 on 6 September. That rise accounts for almost all of the fall in the CRB index. In other words, the fall in the commodities index is mainly due to a stronger dollar, which means that fears over global growth have had very little to do with it.

The “financialization" of commodities, with investors treating them just like any other asset class, may have contributed to keeping their prices high. A recent report by the United Nations Conference on Trade and Development (Unctad) points out that despite the decline in global industrial output after the financial crisis, the most severe in the past 35 years, commodity prices have been well supported compared with during the earlier business cycles. The report also draws attention to the close correlation between the change in oil prices and that in money managers’ positions since mid-2009. For the period between December 2010 and June 2011, this correlation was as high as 0.87. Unctad believes that the herding behaviour of investors often results in commodity prices diverging from the fundamentals of commodity demand and supply.

The UN agency says this can have a major impact on the business cycle. Unctad feels that with investors keeping commodity prices high, this could “provoke a premature tightening of monetary policy" and says it has played an important role in the recent interest rate hikes in India and China.

The report says: “The fact that monetary policy reacts to price pressure stemming from rising commodity prices, rather than to bottlenecks in industrial production, points to a worrying aspect of the impact of financialization that has so far been underestimated, namely its capacity to inflict real damage on the real economy as a result of sending the wrong signals for macroeconomic management." This is precisely the dilemma confronting RBI.

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