Commodities - an overlooked asset class?
The Bank of England’s February Inflation Report mulls over the deflationary effects of people paying off their debts and of the size of the gap between trend and actual output.
However, scarcely more than a paragraph in its 52 pages was devoted to commodity prices. Yet China’s seemingly insatiable demand for raw materials merits greater attention. Take copper, of which China is the world’s largest user: consumption is forecast by some to grow 14 per cent this year, after 20 per cent last year.[1 ]This is hardly surprising when you consider, for example, that China plans to extend its high voltage electricity grid by 26,000km, which implies 750,000 km-worth of copper cable to connect to consumers.[2] To satisfy world demand, as much copper might need to be mined from now until 2032 as has been mined throughout history.[3] Thus the price of copper went up 92.8 per cent in the 12 months to the end of March.[4]
In the 1980s and 1990s, it took global GDP growth of over 3.8 per cent to push commodity prices higher. Between 2001 and 2008, commodity price inflation was generated once growth exceeded around 2.3 per cent.[5] This was simply due to the rapid industrialisation of China and India, and to the fact that supply struggled to meet the increase in demand. If China grows at 9 per cent (and there are no signs that it shouldn’t – in the first quarter of 2010 its GDP grew at 11.9 per cent year-on-year[6]), the rate of GDP growth needed to absorb surplus labour, that equates to 1 per cent in terms of global GDP. So the rest of the world merely has to grow at 1.3 per cent for commodity prices to move higher. The IMF is forecasting global GDP growth of 3.9 per cent[7] this year…so resource-based inflation is likely to start picking up before unemployment in the West has come down much, if at all. Could it be that policymakers may be loath to react to any rise in inflationary expectations if derived from commodity markets?
The perception might then emerge that policymakers would be ‘taking a risk with inflation’. Indeed, this might actively be encouraged, as in the past by the likes of Professor Krugman who, in the case of Japan, advocated that ‘The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible – to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs.’[8] Given that the MPC is ‘required to support the government’s objectives of maintaining high and stable growth and employment’[9] as well as targeting inflation at 2 per cent, the temptation might well arise to follow Krugman’s italicised text to the letter.
[2] Mark Latham Commodity Equity Intelligence Service 22/04/09.
[3]. Ibid, 10/09/09.
[4]. Bloomberg, 14/04/10.
[5] Barclays Capital, 19/05/09.
[6]. Bloomberg, 14/04/10.
[7] www.imf.org/external/pubs/ft/weo/2010/update/01/index.htm
[8] http://web.mit.edu/krugman/www/japtrap.html
[9[ Bank of England Inflation Report, February 2010.
Author: James Codrington
James Codrington heads the charities team at Barings and is a member of the targeted Return Group.
He joined Barings in 2002 and has 14 years' investment experience.
He has an MBA in Mordern History from Oxford University and is a regular speaker at charity events.
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