High Commodity Prices to Persist

Commodity prices have in many cases reached new record high levels over the past year. In spite of high prices the long term trend is still up and likely will be for a long time to come.

Commodity prices are volatile because they respond to many unpredictable factors. Weather, labor strikes, inflation, foreign exchange rates, government monetary policies, and well intentioned but flawed government programs, like the US ethanol production program, all have their part to play in the pricing of commodities on open markets.

In an individual commodity trading account, because your position in futures and options is usually highly leveraged, even a small move against your position may result in a large loss, including the loss of your entire initial margin payment and liability for additional losses. Commodity prices are a double-edged sword for the world economy. High commodity prices are a negative for commodity importers, but a positive for commodity exporters. Commodity prices are currently at or near all time highs. Producers are retiring debt and replacing worn-out equipment but consumers are starting to scream as food shortages and prices beyond what many consumers can readily pay are developing in many countries.

Commodity prices are more volatile than exchange rates and interest rates. Hence commodity price risk represents a more important source of risk to corporations in altering their production costs. Higher prices for raw materials are soon priced into increases in prices for finished goods.

Today commodity prices are high because for one thing China has grown to the point where it is a significant portion of world growth and demand for food and products made from commodities has soared along with China’s high rate of economic growth. Let’s say (as far as commodities are concerned) that China now has roughly the same amount of consumption as the US but that demand is growing more rapidly. With a large percentage of a population of well over one billion experiencing a general improvement in living conditions demand for better food, shelter, and lifestyle is keeping upward pressure on demand for foodstuffs and goods of every sort.

Commodity prices are normally positively correlated with real interest rates, as rate troughs correspond with recession and related weakness in commodity prices. However, this commodity boom cycle is different. Central banks around the world, especially the US Federal Reserve Bank, have tried to support economic growth by keeping interest rates low for long periods of time. The low interest rates have aided “bubbles” to occur in hard assets, especially in commodities.

The central bankers and their policies are a major part of the problem with current high commodity prices. The fall in value of the US Dollar has made this situation worse as many commodities are priced in Dollar terms and a lower Dollar translates into higher commodity prices, no matter what stupid things the US Secretary of the Treasury may say at G-8 meetings.

In the long run commodity prices are less volatile than stock prices. But news shocks, like the current floods in the American Mid West crop producing regions, can strongly drive prices in the short run. Commodity prices are subject to supply and demand factors and sudden shocks to the supply outlook when demand is strong can send prices sharply higher in just a few trading sessions.

Futures are traded on a variety of international commodity exchanges. Futures trading reduces the risk for producers of raw materials - a good example is a farmer, who must risk the cost of producing agricultural goods without knowing the price they will earn on the market several months later.

Corn is an example of a crop with a current run-up in price. This price run up is partly due to new alternative uses and part to weather conditions. A growing proportion of the corn crop is now going into the production of ethanol, which is a clean-burning alternative to oil-based gasoline. Corn prices have been impacted by American subsidies for biofuel.

Other special micro economic factors are relevant in other specific sectors. Corn ethanol, always environmentally suspect, turns out to be environmentally disastrous. Even cellulosic ethanol made from switch grass, which has been promoted by eco-activists and eco-investors as well as by President Bush as the fuel of the future, looks less green than oil-derived gasoline.

Diesel prices are up 30% and industrial natural gas prices are up 15% in the last three months. The prices for both have continued to rise during all of 2008. Diesel costs are far more than $4 per gallon in all states. According to the National Agricultural Statistics Service (NASS), fertilizer prices increased 37 percent overall from March 2007 to March 2008, though in some cases specific fertilizers have doubled or tripled in cost.

Biofuels are seen as an important response to climate change, but risk increasing the competition for agricultural land. Research on multiple-use plants that can provide food, fibre and animal feed can address some of these issues. Biofuel demand, high energy costs, commodity speculation, and strong demand as the earth’s population continues to soar will continue to keep food prices high in the long term, despite periodic dips in price. Climate change is expected to increase food prices by driving down future crop yields.

Wheat prices and therefore flour prices are up significantly compared to last year and compared to historical values. That is likely to continue as wheat continues to fight for planted acres verses corn and soybeans.

2008 is shaping up to be a disastrous year for consumers across the globe. Weather conditions of too much rain and flooding in some key crop producing areas are matched by drought conditions in others. Industrial commodities like crude oil, natural gas, copper, aluminum, and nickel, are rocketing higher as high growth rate economies like China and India develop a large middle class who demand a higher standard of living which includes automobiles and air conditioning.

No doubt a crisis stage is being reached as the price of basic commodities, especially those in making food like rice, wheat , soybeans, and corn, are being priced at record levels that make their purchase by billions of needy people around the earth difficult if not impossible.

It is highly likely that the world as we have known it is coming to an end. High commodity prices are likely to remain high and to move even higher as weather and man made problems, like wars in critical oil producing regions of the world, rage on without end.

No one can predict with certainty the outcome of high commodity prices over an extended period of time but it is hard to think that many of us will enjoy the outcome. Even if you are fortunate enough to make a lot of money on commodity futures as prices soar you may find that there is little left to spend that money on if resource and commodity wars spread to every corner of the earth.

When billions of people face starvation and dehydration all bets are off as to the final outcome for civilizations everywhere. 2008 is likely to go into the history books as an unfortunate turning point for the progress of mankind.

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