Why commodity prices are likely to fall further

Large movements in the prices of oil, minerals and agricultural commodities have been among the most salient economic developments of the past two years. The sharp rise in commodity prices for much of this period was virtually impossible to miss. A barrel of Brent crude that sold for $20 in April 2020, during the first wave of the COVID-19 pandemic, peaked at $122 in March 2022, just after Ukraine invaded Ukraine. Russia.

Oil was not the only commodity to experience a price spike. The price of copper has doubled; wheat has more than doubled; and global commodity price indices nearly tripled from April 2020 to March 2022. And those increases are in dollars; prices in euros, yen, won or other currencies have increased further.

Less widely noted, however, is that prices for many commodities have fallen this summer. The price of oil fell by around 30% between the beginning of June and mid-August. The politically sensitive price of gasoline in the United States fell 20% over the same period, from $5 per gallon to $4 per gallon. The overall index fell by 12%.

Is this decline in commodity prices only temporary? Or is this a sign that prices have peaked and can be expected to continue falling?

Commodity prices are highly correlated. One of the reasons is the direct microeconomic links. When the price of oil rises, costs for wheat growers rise (because harvesting equipment runs on diesel and fertilizers are made from natural gas), putting upward pressure on grain prices.

There are two macroeconomic reasons to believe that commodity prices in general will fall further. The level of economic activity is obviously an important determinant of the demand for raw materials and therefore of their prices. Less obviously, the real interest rate is another key factor. And the current outlook for global growth and real interest rates suggests a downward trajectory for commodity prices.

Not all prices will drop. Different products tell different stories. For example, the market price of natural gas in Europe is set to rise further as the continent learns to manage winter without Russian supplies. But the trend will likely be down elsewhere.

Strong global growth, particularly in China, may explain the sharp rises in commodity prices of 2004-07, 2010-11 and 2021. Conversely, falling global growth may explain sharp falls in commodity prices. commodities during the Great Recession from mid-2008 to early 2009 and during the pandemic recession from January to April 2020.

Global growth is currently slowing down. The Chinese economy has collapsed dramatically. Growth there actually turned negative in the second quarter, as Shanghai and some other major cities suffered lockdowns under President Xi Jinping’s futile zero COVID policy. The European economy will be hit hard by the side effects of the Russian invasion of Ukraine.

Even US growth is slower in 2022 than it was last year, with many proclaiming that a recession has begun. (Personally, I’m always willing to bet that no US recession started in the first part of the year and that first or second quarter GDP will be revised upwards by the end of September. )

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