New Zealand’s commodity prices have increased by 17% this year and is expected to increase by 22% by December 2021. What has caused this increase in prices? With Covid restrictions lifted in many countries this has seen an increase in demand especially from China and South East Asian countries. Dairy, horticulture and forestry commodity prices have been the big winners. Kiwi fruit returns are expected to be the highest on record and log prices have increase over 20% in the last 6 months. Furthermore with the opening up of restaurants in the northern hemisphere the demand for meat will undoubtedly increase which is a good omen for sheep and beef farmers. At this time of year lamb prices normally fall but prices have actually increased over April and May.
Shipping costs have been very high of late but as they start to come down with more supply this will be a further boost to exporters especially bulky exports like forestry. It is expected that wood export volumes will be approaching record high levels over 2021 and 2022. The strong return from commodity prices will mean higher national incomes and will support the strength of the NZ$ and interest rates.
This could be a honeymoon period for New Zealand exporters as supply will eventually catch-up with demand and bring down prices. From a longer-term perspective, environmental constraints are biting on global food production. New Zealand’s dairy sector is at the coal face and the demands by government for fencing and other environmental restrictions means that there is less land being used and lower stock numbers. Other dairy exporters in Europe are also experiencing the same restrictions and it is the consumer who is likely to bear the increase in costs with higher retail prices.
Source: Economic Overview. Reshaping the world. May 2021
The 1983 movie ‘Trading Places’, staring Eddie Murphy and Dan Aykroyd tells the story of an upper class commodities broker Louis Winthorpe III (Aykroyd) and a homeless street hustler Billy Ray Valentine (Murphy) whose lives cross paths when they are unknowingly made part of an elaborate bet.
There is a great part in the movie when they are on the commodities trading floor that explains price and scarcity. Winthorpe and Valentine are up against the Duke Brothers in the Frozen Concentrated Orange Juice (FCOJ) futures market.
How a futures market works As opposed to traditional stock/shares futures contracts can be sold even when the seller doesn’t hold any of the commodity. For instance a contract of $1.30 per pound for a 1000 pounds of FCOJ in February indicates that the seller is compelled to provide the produce at that time and the buyer is compelled to buy the produce. Here’s how it worked in the movie The Duke Brothers believe they have inside knowledge about the crop report for the orange harvest over the coming year. They are under the impression that the report will state the harvest will be down on expectations which will necessitate greater demand for stockpiling FCOJ – this will mean more demand and a higher price. Therefore at the start of trading the Dukes representative keeps buying FCOJ futures. Others saw they were only buying and wanted in on the action, those that had futures were not willing to sell so the price kept rising. However the report was fake and Winthorpe and Valentine had access to the genuine report which stated that the orange harvest had not been affected by adverse weather conditions. Knowing this they wait till the the price of FCOJ reaches $1.42 and start to sell future contracts.
Then when the crop report is announced and it indicates a good harvest investors sell their contracts and the price drops very quickly. The Dukes are unable to sell their overpriced contracts and are therefore obliged to buy millions of units of FCOJ at a price which exceeds greatly the price which they can sell them for. In the meantime Winthorpe and Valentine for every unit they sold at $1.42 they only have to pay $0.29 to buy it back to fulfill their obligation. This results in a profit of $1.13 per unit.
Over the years the store value of notes and coin hasn’t maintained its value like gold. Gold has been seen as a way to pass on the wealth of one generation to the next. What are some other reasons why gold goes up in price:
The US dollar is seen as the reserve currency and when its value drops there tends to be move towards buying gold as security and this ultimately increases its price. After the GFC of 2008 the price of an ounce of gold went from approximately $1,000 to $1,900.
Geopolitical uncertainty also sees people look to gold for relative safety – a good example was the drone strike that killed Qassem Suleimani, leader of the Quds Force of Iran’s Islamic Revolutionary Guard Corps. The price of gold rose around 3% one week after the event. The events of 9/11 saw gold rise by 6% – see Economist graphic.
Gold is also very prevalent in the culture of some countries. India is one of the largest gold-consuming countries and it mainly used for jewellery.
Below is a clip from the Corporation Documentary where commodities trader Carlton Brown gives his reaction on the trading floor when the events of September 11 were unfolding. He talks of the price of gold ‘exploding’.
Sand has become an integral part of the global economy and also the most extracted material. It is used in the construction industry where it is part of the process in making concrete and asphalt. Fine sand tends to be used to produce glass and electronics.
Since the GFC in 2008 Asian countries have been the big users of sand with China consuming up to 40% of world supply (Asia 70%) building 32.3m houses and 4.5m kilometers of road between 2011 and 2015. See graph from The Economist.
Although hard to believe, sand is becoming scarce as desert sand is too fine for most commercial purposes. Furthermore the cost of transporting sand can be very expensive in relation to the price and reserves need to be located near construction sites to make it more economical. By contrast Singapore and Qatar are big importers of sand to assist in their construction programme (especially the latter with the Football World Cup in 2022). Sand is also demanded to create more living area in a country. As is well documented, China has built fake island on coral reefs in the South China Sea. Japan has also claimed a lot of land by dumping vast amounts of sand.
Sand is being extracted at an increasing rate and this is having an impact on the environment with water levels in lakes being lowered and beaches in resort areas of the Caribbean and northern Africa. Indonesia and Malaysia have now banned sand exports to Singapore as a result of thinning coastlines. But with limited supply comes a higher price and with a higher price the black market starts to become prevalent. In India the illicit market for sand is valued around $2.3bn a year. Also the rising price of sand will lead developing-country builders to source alternatives to sand
Sand – elastic in demand as there are substitutes:
*Sand could be classifies as elastic as there are substitutes:
*Mud can be used for reclamation
*Straw and wood to build houses
*Crushed rock to make concrete.
With the continued growth of construction and manufacturing output global demand for sand is forecast to increase 5.5 percent to 291 million metric tons in 2018, with a value of $12.5 billion. Whether the supply can cope with this increase demand is another question. Higher prices will make illicit mining more attractive.
Sources: The Economist 1-4-17. Freedonia – World Industrial Silica Sand
Commodities have been the engine of growth for many sub-Saharan countries. Oil rich nations such as Nigeria, South Africa and Angola have accounted for over 50% of the region’s GDP whilst other resource-intensive countries such as Zambia, Ghana and Tanzania to a lesser extent.
I have mentioned the ‘resource curse’ in many postings since starting this blog. It affects economies like in sub-Sahara Africa which have a lot of natural resources – energy and minerals. The curse comes in two forms:
With high revenues from the sale of a resource, governments try and seek to control the assets and use the money to maintain a political monopoly.
This is where you find that from the sale of your important natural resource there is greater demand for your currency which in turn pushes up its value. This makes other exports less competitive so that when the natural resource runs out the economy has no other good/service to fall back on.
However it is the fall in commodity prices that is now hitting these countries that have, in the past, been plagued by the resource curse. As a lot of commodities tend to be inelastic in demand so a drop in price means a fall in total revenue since the the proportionate drop in price is greater than the proportionate increase in quantity demanded.
The regional growth rate for 2016 is approximately 1.4% but it is not looking good for commodity driven economies:
Nigeria – oil – 2016 GDP = -2%
Angola – oil – 2016 GDP = 0%
South Africa – gold – 2016 GDP = 0%
In 2016 resource rich countries will only grow by 0.3% and commodity exporting countries have seen their exports to China fall by around 50% in 2015. Furthermore, public debt is mounting and exchange rates are falling adding to the cost of imports. With less export revenue the level of domestic consumption has also decreased.
It is a different story for the non-resource countries of sub-Sahara. It is estimated by the IMF that they will grow at 5.6%. By contrast they have been helped by falling oil prices which has reduced their import bill and public infrastructure spending which has increased consumption.
As is pointed out by The Economist numbers should be read wearily as GDP figures are only ever a best guess, and the large informal economy in most African states makes the calculation even harder. Africa may have enormous natural reserves of resources, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from resources. There is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports. What is needed is diversification.
The Economist has a graph showing the change in price of commodities from 5th January 2016 to 18th October 2016. The change in price is purely reflected in simple supply and demand theory. In 2015 raw material price dropped mainly because of over-supply. The main points from the graph are:
Oil – $50 per barrel – expectations that supply might decrease by OPEC countries
Sugar – price up by 56% – unfavorable weather therefore supply decreases
Grain – prices down by 9% – bumper harvests in the USA
Below is a video from the FT that I showed my A2 class this morning. The significance of it is the Australian dollar and how its value is strongly linked to iron ore prices. Recent growth in China has exceeded expectations and this has led to a rebound in commodity prices especially iron ore. The belief is the AUS$ is higher than the equilibrium level suggests and that this rate will not be sustainable. There are two reasons for this:
Commodity prices have accelerated which has led to more demand for AUS$ which might not be sustained.
Higher relative interest rates has made the AUS$ strong as ‘hot money’ has been attracted in the country. The Reserve Bank of Australia (central bank) has recently cut the cash rate (interest rates) to 1.75% and there is talk of a further cut this year.
Below are some interesting graphs and comments from a recent ANZ Bank presentation which address the issue of unemployment.
Both cyclical and structural factors seem to have played an important role in the recent recession. From a cyclical point of view output and the unemployment rate of the economy reflect this and should recover to pre recession levels. Structural change involves the shift of resources from slower growing areas of the economy to faster growing areas. Indicators such as the savings rate and employment in the different sectors of an economy, seem to be driven more by structural changes and might not return to levels seen before the recent recession.
Economists spend a lot of time talking about the “cycle”, but this can be at the expense of the “trend”.
And isn’t it the trend that is more important for businesses?
We can get bogged down in the detail and forget about some of the high level themes that dominant
Often these trends or themes can be relatively clear. But a lot of the time they are not.
Arguably, today’s economic backdrop is one where there are more questions over the overarching trends than the cycle itself (although that is not that clear either!).
The price of copper is on the up. Below are some Supply and Demand factors.
Supply curve shifts to the left.
Disruptions to production in
* Peru – protests
* Chile – strikes
* Zambia – power shortages
Demand curve shifts to the right
In the light of fast-modernising its power grid the demand for copper in China is vast.
“Copper consumption estimates for China are being revised up. Huge spending on copper-intensive power infrastructure on the state grid in ‘rural areas’ will continue through 2012 (12 bn RMB). Beijing has also renewed the ‘home appliance subsidy scheme’ and is promoting electric cars, which are twice as copper-intensive as conventional vehicles.” – Patricia Mohr, Economist, Scotiabank
The recent drop in commodity prices has some economies very hard:
Russia – debt looks as if it is going to be downgraded to junk status Venezuela – is on the verge of defaulting Brazil – growth forecast cut Norway – significant cut in government revenue
However some other commodity exporting countries are coping with this fall in prices. Chile and Peru which are dependent on metal exports are forecast to grow 3% and 5% respectively. Furthermore no Middle Eastern country is expected to enter a recessionary phase. The Economist identifies two factors that explain why some commodity exporters are coping better with lower commodity prices.
1. Business Friendly – Many countries have made their economies more business friendly – believe it or not according to the World Bank Rwanda is a better place to do business than Italy. Benign business environments encourage foreign direct investment – Africa has encouraged FDI despite the global economic conditions.
2. Prudent Government Spending – when commodity prices were high and tax revenue was growing a lot of countries increased their expenditure significantly. However the opposite applied when prices fell as they no money to boost domestic demand.
As Keynes used to say – save when times are good and spend when times are bad.