The Wall Street Journal
CAPITAL
Updated April 25, 2012, 7:09 p.m. ET

Hot Commodity: Research on Prices
By DAVID WESSEL

Gold glitters, of course. It has for centuries. The world economy turns on the ups and downs of oil prices. Rising food prices threaten even the toughest dictatorships. Commodity prices matter — and not just to traders and investors.

For decades, commodity prices fell almost inexorably. But around 2000 they turned up, sparking plausible predictions about the onset of a "commodity supercycle," a very long stretch of unusually large and sustained price increases. Looking back to 1865, economists José Antonio Ocampo, a former Colombian finance minister and recently a candidate for World Bank president, and Bilge Erten of the United Nations statistically identified three such cycles; they declared our time to be the fourth.

commodity prices from 1973 to 2011 The recent global financial crisis disrupted every market, but then commodity prices resumed their upward climb. That reinforced the supercyclists' case, as well as the argument that commodity prices reflect markets' fear that central banks were printing so much money that inflation was inevitable. But lately, a softening of some commodity prices has undermined the supercycle view.

Traders and investors care about this for obvious reasons, but it also matters to economies that depend heavily on either exporting or importing commodities, as well as to inflationary pressures around the world.

To help distinguish temporary trends from long-lasting ones, International Monetary Fund economists recently charted the inflation-adjusted prices of four baskets of commodities — energy, metals, food and agricultural raw materials (such as logs, cotton, rubber, wool and others) since the 1970s. For what it's worth, the IMF's bottom line: "The weak global economic outlook suggests that commodity prices are unlikely to increase at the pace of the last decade."

But the IMF charts illuminate a bigger story.

♦ Something significant did happen in the 2000s: a sea change in what had been a downward drift in prices of commodities (other than energy) for decades. The consensus explanation: Demand from China, India and other emerging markets grew very rapidly as these big economies sprang to life. At the same time, investors around the world decided that commodities were a big bet. This increased demand came after a long spell of falling prices, which discouraged investment in expanding commodity production. The world was unable to increase supply rapidly to satisfy this new demand. Prices rose.

♦ Energy prices are truly different. For one thing, they are much more volatile than other commodity prices for all sorts of reasons, including recurring geopolitical risks that oil supplies will be disrupted. For another, they are clearly rising — up 163% over the past four decades. The consensus explanation of energy's exceptionalism: Rising oil prices depress economic growth and that depresses prices of other commodities.

♦ Metals prices have risen significantly in the past several years, as the IMF chart shows. This reflects strong demand by industry and investors, perhaps amplified by a loss of confidence in currencies and governments. Still, metals prices are roughly where they were in 1973, a clear contrast to the price of energy, which appears unlikely to ever be as cheap as it was then.

♦ Over the past several decades, the price of food is down substantially — despite the growth in the world's population and the well-discussed change in the diets of the increasingly prosperous Chinese, and even after the uptick of the late 2000s. Food prices are roughly half what they were in 1973. Half. That long-lived trend is likely to continue. Indeed, the Ocampo-Erten research finds that, except for oil, the upswing in each supercycle has been followed by a downswing that leaves prices lower than they were at the end of the previous decade.

So where are we in this supposed supercycle? At the end? Or just in the middle?

On the demand side, there isn't another China or India to enter the global market, so that huge source of increased demand won't recur. Investors?

Well, with interest rates so low, CPM Group commodity guru Jeffrey Christian suggests there could be another wave of investor money flooding into commodities.

On the supply side, the predictable reaction is under way: a surge in investment in commodity-producing capacity from copper to natural gas that will increase supply, along with a renewed drive to develop technologies that use commodities more efficiently. "The constraints are really political and social at this point," said Mr. Christian, referring to political, legal and environmental obstacles to more mining, energy exploration and agricultural harvesting.

Supercycle, it turns out, may be just a fancy name for the familiar forces of demand and supply in which a demand-driven increase in prices provokes an increase in supply that pushes prices down again.

Write to David Wessel at capital@wsj.com

A version of this article appeared April 26, 2012, on page A4 in some U.S. editions of The Wall Street Journal, with the headline: Price Check: The Costs of Essentials.


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