World Commodity Prices and Markets Dr Wyn Morgan Sixth form Conference 27th June 2006.

World Commodity Prices and Markets

Dr Wyn Morgan

Sixth form Conference

27th June 2006

Question: what links Chinese economic policy with a crime committed in Sinfin in June?http://news.bbc.co.uk/1/hi/england/derbyshire/5011174.stm

Answer: the price of copper. Why?

China is growing rapidly and demanding commodities such as copper, thus prices have risen sharply

Criminals see prices rising and try to “supply” some from a community centre!

Figure 1: Copper Prices $/tonne (July ’05-June ’06)

Source: BBC

Source: COMTRADE.

Figure 2

China's primary imports from world and from Africa, by major commodity group,average annual rate of growth, 1994–2003

per cent

0

10

20

30

40

50

60

Total primarycommodities

Food Agricultural rawmaterials

Fuels Ores and Metals

World Africa

Outline

1. Commodities defined

2. The main features of commodity markets

3. Price behaviour

4. Policies for commodity markets

5. Conclusions/questions

1. Commodities Defined

“A commodity is something that hurts when you drop it on your big toe, or smells bad if you leave it out in the sun too long”

(Barron’s 27th June 1983)

Primary commodities are “natural” and have not been processed into other products

What types of internationally traded primary commodities are there?

Food/Beverages

Coffee, cocoa, sugar, wheat, maize, rice, bananas, beef

Minerals and Metals

Tin, copper, zinc, nickel, iron ore, aluminium

Agricultural Raw Materials

Rubber, cotton, tobacco, oilseeds, soybeans, oils (palm, groundnut)

Fuels

Oil, gas and coal

2. What are the Main Features of Commodity Markets?

Major share of world trade

•23% including fuels

•14% excluding fuels

•Many countries export & import (see Table 1)

•Most DMEs net importers (except Australia and Canada)

Demand – generally stable

•Necessities (e.g. food)

Low degree of substitution

Low income elasticity for food

•Inputs into manufacturing production:

Copper in construction or palladium for mobile phones

Some substitution (e.g. rubber)

Supply – can be volatile

•Not just developing countries (see Table 2)

•Time period for supply means short run is a long time and elasticity low e.g.:

Minerals need new mines

Coffee bushes need 7 years to mature

•Effect of shocks

Permanent - new processes

Temporary - weatherhttp://business.timesonline.co.uk/article/0,,9065-2236557.html

Graph 1: Commodity Market with Supply Shock

Price

Quantity

S1

D

S2

P2

P1

Q1Q2

S3

P3

Q3

Graph 2: Commodity Market with a Demand Shift

Price

Quantity

S

P1

Q1

D1

D2

P2

Q2

3. Price Behaviour

Commodity prices exhibit two main features:

1. A high degree of volatility (see Table 3) arising mostly from supply volatility

2. Downward trend relative to manufactured goods

Figure 3: Nominal Quarterly Commodity Prices (1957Q1 = 100)

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

1957

Q1

1958

Q3

1960

Q1

1961

Q3

1963

Q1

1964

Q3

1966

Q1

1967

Q3

1969

Q1

1970

Q3

1972

Q1

1973

Q3

1975

Q1

1976

Q3

1978

Q1

1979

Q3

1981

Q1

1982

Q3

1984

Q1

1985

Q3

1987

Q1

1988

Q3

1990

Q1

1991

Q3

1993

Q1

1994

Q3

1996

Q1

1997

Q3

1999

Q1

2000

Q3

Figure 4: Real Commodity Prices (Deflated by US Price Index)

100

150

200

250

300

350

400

450

1957

Q1

1958

Q2

1959

Q3

1960

Q4

1962

Q1

1963

Q2

1964

Q3

1965

Q4

1967

Q1

1968

Q2

1969

Q3

1970

Q4

1972

Q1

1973

Q2

1974

Q3

1975

Q4

1977

Q1

1978

Q2

1979

Q3

1980

Q4

1982

Q1

1983

Q2

1984

Q3

1985

Q4

1987

Q1

1988

Q2

1989

Q3

1990

Q4

1992

Q1

1993

Q2

1994

Q3

1995

Q4

1997

Q1

1998

Q2

1999

Q3

2000

Q4

Figure 5: Nominal Quarterly Commodity Prices (1957Q1 = 100)

160.0

180.0

200.0

220.0

240.0

260.0

280.0

300.019

80Q

1

1980

Q4

1981

Q3

1982

Q2

1983

Q1

1983

Q4

1984

Q3

1985

Q2

1986

Q1

1986

Q4

1987

Q3

1988

Q2

1989

Q1

1989

Q4

1990

Q3

1991

Q2

1992

Q1

1992

Q4

1993

Q3

1994

Q2

1995

Q1

1995

Q4

1996

Q3

1997

Q2

1998

Q1

1998

Q4

1999

Q3

2000

Q2

2001

Q1

2001

Q4

Commodity Price Index

Figure 6: Real Commodity Prices 1980-2000 (Deflated by US Price Index)

140

160

180

200

220

240

260

280

300

Do these features represent a problem?

Volatility

•Input price volatility

Labour and capital costs known, other inputs not – what happens?

Who pays for this? Inflation effects?

•Selling price volatility

Producer income unknown

Investment difficulties

Downward Trend

•LDC producers rely on export revenues

•Need manufactured goods for growth

•Try to produce more to increase revenues: Y = PQ

Increase Q to offset fall in P but this causes P to fall!

•Problem of dependence on a few commodities for export earnings (see Table 4)

4. Policies for Commodity Markets

What do countries want?

•DMEs want good supplies but with stable and “fair” (low??) prices

•LDCs want increased export earnings but want them to be stable (high prices??)

How can these be reconciled?By “managing” the market

International Commodity Agreements

•Buyers and sellers control supply to keep prices in a stable range

•Supply controlled by production limits, export quotas, buffer stocks etc

Graph 3: Price Bands in a Commodity Market

Price

Quantity

S

D

Pu

Pe

Qe

PL

International Commodity Agreements•Buyers and sellers control supply to keep prices in a stable range

•Supply controlled by production limits, export quotas, buffer stocks etc

•Existed for a number of commodities: sugar, coffee, cocoa, rubber, tin

•All collapsed due to disagreements between the two sides

One-sided interventions

•Supply control by producers (cartels)

e.g. OPEC

Controls supply by quotas and can increase prices (see 1973/4 on Figure 1)

•Protection of domestic producers

e.g. Common Agricultural Policy

Use tariffs and artificial prices to raise incomes for EU farmers

Impact on world markets significant

Other Policy Issues in Commodity Markets

•Development and growth concerns

•Diversification of production in LDCs

•Inflation in DMEs

•Environmental concerns

•Technological change and its effects

•Market power and prices

•Risk management

5. Conclusions/Questions

• Commodities are important for both LDCs and DMEs

• Commodity markets have stable demand but potentially volatile supply

• Prices can be volatile in short run and downward trending in the long run

• Intervention can affect prices but what are the welfare implications of such policies?