econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 21 March 2016

What Tracks Commodity Prices?

from Liberty Street Economics

-- this post authored by Thomas Klitgaard and Harry Wheeler

Various news reports have asserted that the slowdown in China was a key factor driving down commodity prices in 2015. It is true that China's growth eased last year and, owing to its manufacturing-intensive economy, that slackening could reasonably have had repercussions for commodity prices. Still, growth in Japan and Europe accelerated in 2015, with the net result that global growth was fairly steady last year, casting doubt on the China slowdown explanation.

An alternative story relies on the strong correlation between the dollar and commodity prices over time. A simple regression shows that both global growth and the dollar track commodity prices, and in this framework, it is the rise of the dollar that captures last year's drop in commodity prices. Thus a forecast of stable global growth and a relatively unchanged dollar suggests little change in commodity prices in 2016.

Prices Are Correlated with Global Growth

Commodity prices tend to fall when the global economy falters and rise when it is booming. The chart below compares global growth, as measured by the International Monetary Fund, with the annual percentage change in the Commodity Research Bureau price index for raw industrial goods (various metals, cotton, rubber, wool, and other goods). The two lines move together, with a regression using global growth having an R-squared of .52. That is, global growth explains around 50 percent of change in this commodity price index over this period. Looking at the chart, the closest co-movements are from 2004 to 2007 - when the world economy was growing at an annual pace of more than 5 percent and the commodity price index was rising 15 percent per year - the collapse in growth in 2008-09, and the rebound in 2010-11. However, this relationship struggles to explain the 1995-96 and 2012-15 periods, with the latter being one of stable global growth and steep commodity price declines in both 2012 and 2015.

LSE_2016_growth-commodities_klikgaard_chart1_art

The stability of global growth does not necessarily preclude China's flagging growth from having a significant role in the decline of commodity prices last year. In particular, China is more commodity-intensive than Japan and Europe and this shift in composition of growth last year is hidden in the global growth variable. Breaking down global growth into emerging and advanced countries reveals that the volatility of commodity prices is better captured by the growth of emerging economies than the growth of advanced economies. Some of this may be due to commodity prices affecting the economies of commodity-producing countries. Still, growth in emerging economies only slowed by half of a percentage point in 2015, so this variable is not enough to explain last year's steep decline. Also, note that a regression using global growth does a better job tracking commodity prices than one that relies only on the growth of emerging economies.

Prices Are Also Correlated with the Dollar

Analysts looking for another explanation of last year's price decline point to the strong correlation of commodity prices with the dollar - commodity prices tend to fall (rise) when the dollar appreciates (depreciates). One theory is that prices fall when the dollar strengthens because commodities priced in dollars become more expensive to the rest of the world, thereby restraining demand. It is a plausible explanation, but it is also quite possible that the dollar is not a causal factor and is instead correlated with other underlying factors affecting commodity prices.

The next chart shows these two data series with the dollar index of major currencies inverted so that the relationship is easier to see. (That is, a fall in the inverted dollar index means the value of the dollar is increasing.) Commodity prices show a strong correlation with the dollar, but not quite as strong as they do with global growth, with the R-squared statistic equal to .43. There are many time periods when the two variables move together, with 2015 being one such example.

LSE_2016_growth-commodities_klikgaard_chart2_art

So, what happens when these two variables are used together to track commodity price movements? The results of a regression show that the variables are each statistically useful in tracking commodity prices, with global growth and the dollar able to explain 68 percent of the movement in commodity prices. Note that the large coefficient on global growth offsets the large negative constant term, so that 3 percent growth in global output and a stable dollar would predict no change in commodity prices. As for the dollar, a 1.0 percent increase in this dollar index corresponds to a 0.9 percent drop in the commodity price index.

LSE_2016_growth-commodities_klikgaard_chart3_art

The regression does not use the whole sample in order to see how well the estimated coefficients fare in recent years. The out-of-sample prediction of the model starting in 2012 is pretty good. It under-predicts the drop in commodity prices in 2012, yields a 2 percent decline in commodity prices for both 2013 and 2014 when the index was unchanged, and does very well in predicting last year's steep decline. The chart includes a forecast for 2016, using the IMF's outlook for global growth and the dollar's value in January and February 2016 as the average for the year. These assumptions, of a slight acceleration of global growth and a slight appreciation of the dollar, project that commodity prices will remain essentially unchanged this year.

Considering an Alternative Commodity Price Index

In case you are wondering if the results are driven by our choice of price index, we repeat this last exercise in the chart below using an alternative measure of commodity prices - namely U.S. import prices of industrial supplies, which includes a much broader array of commodity-type goods, such as steel and lumber. The results are similar, with global growth and the dollar capturing most of the movement in this price index. Again, based on the growth and dollar assumptions, the regression predicts the index will be stable in 2016.

LSE_2016_growth-commodities_klikgaard_chart4_art

Each commodity is influenced by a variety of supply and demand factors in its specific market. Nevertheless, the simple model presented here does well at tracking two broad commodity price indexes. That global growth helps explain commodity prices is not surprising, while the role of the dollar is more difficult to explain. Looking forward, the results suggest commodity prices will stabilize in 2016 if growth and the dollar unfold as expected.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source

http://libertystreeteconomics.newyorkfed.org/2016/03/what-tracks-commodity-prices.html#.Vu_YZfkrKUk


About the Authors

Klitgaard_thomasThomas Klitgaard is a vice president in the Federal Reserve Bank of New York's Research and Statistics Group.

Harry WheelerHarry Wheeler is a senior research analyst in the Bank's Research and Statistics Group.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.



You can also comment using Facebook directly using he comment block below.





Econintersect Contributors


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
Big Mess in Italy
Are You Feeling the Economic Surge?
News Blog
3Q2016 (Final): Headline Productivity Improves
October 2016 Trade Data Mixed
October 2016 CoreLogic Home Prices Year-over-Year Growth Rate Now Improved to 6.7%.
Taiwan, Trump And A Telephone: How A Simple Act Called Out A Contradiction In U.S. Diplomacy
Infographic Of The Day: A Beginner's Guide To Encryption
Early Headlines: Asia Stocks Up, Oil Down, GOP Healthcare, Trump Not Reagan Redux, EU Ending?, UK Lost Decade, Putin Taking Over Mid-East, Yuan 'Flash' Crash And More
December 5, 2016 Weather and Climate Report - December Update - Zonal Prevails
Irish Births And Baptisms Visualised
What Happens In The Smartphone Afterlife
Water Intoxication: Are We Drowning In Advice To Drink More Fluids?
The Worldwide Virtual Reality Market Is Set To Be Huge
Average Gasoline Prices for Week Ending 05 December 2016 Rose Over 5 Cents
What We Read Today 05 December 2016
Investing Blog
Momentum Issues A Warning
The Great Bond Crash Of 2016: 05 December Update
Opinion Blog
The Shale-War Is Over
Fake Science
Precious Metals Blog
Silver Prices Rebounded Today: Where They Are Headed
Live Markets
05Dec2016 Market Close: US Markets Close Higher, WTI Crude Settles At $51.09, US Dollar Drops Below 100 Temporally
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government



Crowdfunding ....






























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved