Commodity prices have been showing a downward trend for the last two year due to lack of effective demand conditions across the globe. Coal, iron ore, palm oil, Nymex and Brent crude have all shown sharp fall of 20 to 30 % in the last two years. This is against the background of advanced economies like U.S, Eurozone and Japan central banks doing record amount of stimulus to stimulate demand conditions in the economy. The U.S inflation measured by personal consumption expenditure is running at 1.4 % against the Federal Reserve target of 2 %. PCE is running below Fed target for the last two years. The Eurozone inflation is running at 0.4 % against target of 2% set by ECB. Japan has slipped into recession even with Bank of Japan targeted a 2 % inflation, by buying 80 trillion yen and increasing the monetary base.
The commodity prices have a negative downward trend, as the Chinese government shifts its growth model from export led growth to a model based on internal investment and consumption . China has also embarked on Environment targets to reduce carbon emissions. This has led to close down of some industries particularly in the steel sector. The construction sector in China is undergoing a sharp slowdown as real estate prices have fallen in 699 of the 700 districts for the last two quarters. Iron ore prices have fallen from USD 130 per ton in the beginning of the year to USD 72.10 per ton. This is a five and half year low prices for Iron ore prices.
The banking sector in china is undergoing a huge amount of stress due to high levels of non-performing assets which it is holding. The Chinese government has started to crack down on shadow banking practice which has led to money supply becoming tight for the industry. The Chinese economy has been in the slowdown phrase for the last two years, which had the effect of reducing demand for base metals.
The western world is struck with high levels of debt and these countries are unable to stimulate their economy as the demand from the end consumers is weak. The government is unable to stimulate demand as they are fiscally constraint. The debt to GDP ratio of these countries are high with US Debt to GDP at 72 %, Eurozone at 90 % and Japan debt to GDP ratio at 226%. The U.S is the only economy which is showing signs of improvement, however, the growth in this economy is less commodity dependent due to higher efficiency levels prevailing in the economy.
Oil prices have shown a downward trend with prices down by 30% in the last one year. The supply of oil has increased due to shale gas production in US , increased production from Libya and Iraq. Saudi Arabia due to its various welfare programme which has been initiated is not cutting production to stabilize oil prices. This combined with weak demand in the global economy has led to commodity prices falling in the last one year.
The world economy has seen three super cycle of commodity prices , in the end of the 1900 century when US industrialization started, after the Second World War and china going for massive industrialization. With china rebalancing its economy to make it more consumption dependent rather than export dependent and its focus on reducing carbon emission, china going forward may not be a great consumer of commodities in the near future. With huge capacity created in the commodity sector and the GDP growth in china expected to slow down to 6.5 to 7.5 % . The advanced economies GDP is expected to remain weak in the coming years as they deleverage their economies, the growth is expected to be anemic in these economies.
Moreover with significant capacity created in the commodity sector, commodity prices are expected to be subdued in the coming years. For the commodity consuming nations like US and India this rings in as a positive news.
