Commodity prices in the very long run

In the previous article we took a look at a handful of commodities and compared their current prices to those seen back in 1995.

In this article, we take a longer-term look at a wider range of commodities to see just how prices now compare in real terms to those in the (very) long term.

Firstly, the data (all prices have been rebased to 2015 price levels, using historic US inflation figures):

(click the charts to enlarge)

longterm1

As can be seen, all of the base metals covered here, as well as oil, are now trading at prices below their long-term real averages seen since 1915. Some look particularly cheap – the prices of aluminium and nickel for example are significantly below their long-term real average prices.

Economic theory would generally have it that this is what should be expected. In real terms, prices of goods are generally expected to head down eventually. This is due to improved efficiency through technological advance, and substitution and supply increases should prices increase too much.

Certainly we have historical examples of this, the changing story of aluminium being particularly well-known.

For the unfamiliar, the metal used to be so expensive that Napoleon III (nephew of Napoléon Bonaparte) possessed an aluminium cutlery set for the use of special guests (undeserving guests had to make do with silver). The Washington Monument meanwhile was adorned with an apex made of aluminium during its completion in 1884 in order to demonstrate the USA’s growing wealth and industrial might. The apex is still there today.

Technological advance of course soon turned aluminium into the everyday metal it is now, used in a wide variety of applications from beverage cans to automotive parts.

Oil and nickel throw up other, more recent examples of “human ingenuity” in response to rising prices – fracking and the development of the shale oil industry in the case of oil; the wider use of lower-grade ores and development of the nickel-pig iron industry in the case of nickel.

Looking to the future as well, there has long been speculation that advances in the production of carbon fibre and other composite materials will do away with much of the steel industry. A technological leap in titanium production would likewise have a dramatic impact.

Economists, not typically known for the accuracy of their projections but certainly their confidence, have even placed money on real prices falling over the long term.

During the 1960s and 1970s for example, rising commodity prices brought out renewed Malthusian fears regarding the planet’s resources, impending shortages and mass starvation.

One such pessimist, biologist and author of ‘The Population Bomb’, Paul Ehrlich, agreed to enter into a bet with the economist Julian Simon in 1980, who argued that the prices of any five commodities chosen by Ehrlich (in the end, he chose chromium, copper, nickel, tin, and tungsten) would be lower in real terms once 1990 arrived.

In the end, Simon won the bet comfortably with real prices for all five commodities falling. As he predicted, and used as the title for his own book, human ingenuity was “the ultimate resource”.

But the reality of history shows that the argument is far from clear cut. Analysing the data in the charts above, it can be seen that, during any given 10-year period, real prices have fallen just as often as they have increased. Indeed, there is no notable and overriding downward trend in the charts above. Perhaps Simon just got lucky with his timing.

With this information, is there anything that can be said about the direction of prices over the coming years?

Given that all of the commodities discussed here are now trading at real prices below their long-term historic averages, it would certainly be a brave economist that made the same bet as Simon did in 1980.

At the same time, previous large jumps in prices can be explained – the post-war economic boom in Europe, the oil price shocks of the 1970s, and most recently the rapid economic development of China.

What, if anything, is the next big story? If there isn’t one, demand could take much longer than usual to catch up with the vast expansion in supply created to feed the Chinese economic boom.

The only certainty is that nothing is permanent in commodity markets. This is as true when prices are relatively low, as they are today, as when they are high.

And, just as the cure for high prices is the high prices themselves, so the reverse is true. With losses mounting and announcements of capacity shutdowns increasing in a number of commodity industries, albeit slowly, the cure for the low prices being seen today are the low prices themselves.

Sources: BLS, EIA, MBR, USGS

This article was also published for Steel First in February 2016

 

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