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Commodity prices – just Murphy’s law at work?

Global commodities | Commodity prices – just Murphy’s law at work? Anthony Harrington

Murphy’s Law says that if something can go wrong, it will go wrong. For the last year it seems that Murphy’s Law has been in full swing in the world’s commodities markets. From droughts to floods, the weather has, to say the least, not been kind to those who rely on the soil. In past decades this might not have mattered as intensely as it does today, but with developing economies demanding more rather than less by way of grains and meat, the pressure on soft commodities has been unrelenting and the least shortage quickly feeds through into price hikes.

And it is not just food crops that have suffered. Cotton and rubber are both experiencing huge price pressure. According to recent reports, Thailand, Indonesia and Malaysia, the three biggest rubber producing nations, have seen yields hammered by poor weather. The result? Demand for 2011 is set to outstrip supply, just at a time when the emerging economies of China and India are pushing new car sales to record levels. Tyre makers Michelin and Bridgestone are reported to have responded to the current shortages in global rubber supply by increasing the price of their tyres by up to 15%. No rubber equates to no tyres, which means potentially huge problems ahead for the global auto industry.

According to Bloomberg, this is the second year in a row that growers have been unable to meet demand. While this makes a great forward punt for investors who feel like allocating five percent or so of their portfolio to commodities, the knock on effects could be significant. And it is not just tyres that are likely to see a price hike. Virtually every consumer good with a high rubber content, from condoms to washing up gloves, will see price inflation.  The price of rubber has now tripled over the course of the last two years.

Importantly, there is little in any of the figures coming through which suggests that global demand and supply will not achieve a more balanced relationship in a few years. Much the same could be said of soft commodity prices like coffee, which has doubled in price, or groundnuts, where there is currently a pronounced shortage. This is why some analysts are expecting the current commodity price spike to work its way out of the global economic system within two years or so. However, as Ian Fraser notes in a recent blog, there could be more systemic causes. The Federal Reserve’s “hot money” flowing from QE2 is being blamed for chasing bumper returns from commodities, rather than doing what it was intended to do, namely to stimulate the US economy. What the US definitely did not intend to do was stimulate riots and regime change across the Persian Gulf. Yet this can be an inevitable consequence of stirring up the poor in those regions.

According to the Indonesian Stock Exchange the shortage is not because growers are not taking steps to increase production. Ten years ago the average hectare of growing land would produce between 800 and 900 kilograms of rubber. Today, with improved strains, that has been increased to 1050 kilograms with new clones expected to be capable of producing 2,500 kilograms per hectare. These are dramatic improvements. The International Rubber Study Group (IRSG) says that following a 7.5% decline in 2009 (on the back of a slump in demand through the global recession) global rubber consumption is expected to grow by 15.3% in 2010.

With this scenario, high prices for rubber seem set to continue for several years yet.

Of course, the plus side of this is that small farmers from Vietnam to Thailand have been enjoying bumper prices for their crops and that looks set to continue. Ironically this feeds through into a higher demand for motor vehicles from farmers and rubber tappers, which adds its modicum of pressure to the demand for tyres, and hence to the demand for rubber. Goldman Sachs analysts are predicting prices of 1,200 yen per kilogram by the end of 2011, versus 466 yen or thereabouts today. Again, this will play well in the short term for investors, but it is going to be bad news for manufacturers and for the consumer. It demonstrates the scale of the commodity-driven inflationary pressures out there and suggests that central banks in both developed and developing economies are going to have to start raising rates. That can’t be good for growth in the developed world...

Further reading on global commodities:

Tags: commodities , cotton , Federal Reserve , grains , loose money , rubber prices , soft commodities
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