Macroeconomic Developments On Commodity Prices

Influence Of Macroeconomic Developments On Determination Of Commodity Prices

Introduction:

            Questions related to the determination of prices for oil and other mineral and agricultural commodities have always fallen predominantly in the province of microeconomics. “Nevertheless, there are times when so many commodity prices are moving so far in the same direction that it becomes difficult to ignore the influence of macroeconomic phenomena. The decade of the 1970s was one such time; recent history provides another. A rise in the price of oil might be explained by ‘peak oil’ fears, a risk premium related to instability in the Persian Gulf, or political developments in Russia, Nigeria or Venezuela. Spikes in certain agricultural prices might be explained by drought in Australia, shortages in China, or ethanol subsidies in the United States. But it cannot be a coincidence that almost all commodity prices rose together during much of the past decade, and peaked so abruptly and jointly in mid-2008” (RBA, 2009).

Looking at the determination of the prices factor for the minerals, oil and agricultural commodities it has mainly fallen in the region of the subject- microeconomics. But in the phase when it was said that many commodity prices were in movement in the similar direction and that in the very similar time as well, at that point it becomes crucial to not ignore the influence of macroeconomics.

 

Fear of “peak oil”, the rise in oil prices, may be elucidated by the political situation in Venezuela Russia or risk premium, unstable Gulf, and Nigeria. Farm price some may be described by grants of ethanol in the U.S. drought in Australia, or scarcity in China. However, it cannot decades, all product prices will raise together much almost, peak to chance suddenly in mid-2008.oil.

 

“COMMODITY MARKETS play a central role in transmitting disturbances internationally by linking commodity importing countries to commodity suppliers. Given the marked fluctuations in both prices and volumes in recent years, it is important to re-examine the underlying macroeconomic factors that have an impact on this market and that must be taken into account in the design of policy, particularly for those countries that rely heavily on primary commodity exports and that are facing substantial terms of trade shocks” (Borensztein, E. and Reinhart, 1994).

 

In the past 10 years, of course, there is additional space of instability in the world economy. These changes in the flow of financial resources, including fluctuations in exchange rates of major currencies, the speculative funds from commercial capital markets and interest rates are included,  Instability in these areas and to interact which has strengthened the fluctuation of commodity market.

 

In order to reflect the relative purchasing power of different currencies, it recognized the need interest rates to reduce the early 1980s from a high level historically, agreement is related to the exchange rate more closely the need for achievement in the a large amount of developed countries but there has been a realization in the coordinated action, but to hold up, it has come into view within the high opinion to commodity prices still.

 

It is important for growth and complete sustainable development in developing countries of commodity reliance; quite a lot of policies have been projected in this memorandum. More specially, the augment in funds for investment and investigation of renewable energy to hold back carbon, greenhouse gas (GHG) emissions, that is not made concerted hard work is at the expense of economic benefits since in this manner, environmental health and human should be made to progress the guidelines to monitor the shale oil and gas production.

 

Literature Review:

            Before conducting our main research and developing our research question it is highly important that we take a good look at the theory of the commodity prices and their relation to the macroeconomic activity in a country. The previous research work conducted in this field would give us an overview of the major macroeconomic factors that play an important in the price determination of the commodities. With the help of these factors we can dig deep into the process of price determination and thus can develop our hypothesis which then further leads us to our research questions and research objectives.

 

“The first study that we would discuss was conducted by Jeffrey A Frankel and Andrew K Rose named “Determinants of Agricultural and Mineral Commodity Prices”. The main aim of the study was to present a theoretical model of the determination of prices for storable commodities that gives full expression to such macroeconomic factors as economic activity and real interest rates. However, it does not ignore other fundamentals relevant for commodity price determination. To the contrary, the model includes a number of microeconomic factors including (but not limited to) inventories. The paper then estimates the equation using both macroeconomic and commodity-specific microeconomic determinants of commodity prices.  When the data were aggregated across commodities: inventories, uncertainty, speculation, economic growth and expected inflation, the hypothesis that was developed gained support The end result shows that real interest rate does not have a significant effect” (RBA, 2009)

“The results showed that economic activity, inventories, uncertainty, the spread and recent spot price changes influence the prices of commodities. The significance of the inventories variable supports the legitimacy of arguments by others who have used observed inventory levels to gauge the roles of speculation or interest rates”  (RBA, 2009).

“The second research done in this regard was under the supervision of International Monetary Fund’s research department on the topic “The Effect of Economic News on the Commodity Prices: Is Gold Just another Commodity?” An event study methodology technique is used in the paper to see that which macroeconomic factors affect the prices and how do they affect. Results show that gold is unique among commodities, with prices reacting to specific scheduled announcements in the United States and the Euro area (such as indicators of activity or interest rate decisions) in a manner consistent with gold’s traditional role as a safe-haven and store of value. Other commodity prices, where such news is significant, exhibit pro-cyclical sensitivities and these have risen somewhat as commodities have become increasingly financialzed.” (IADB 2009).

“A daily price data for 12 commodity future contracts was used over the period from January 1997 to June 2009.The results obtained suggest that commodities are not just financial assets and gold is not just another commodity. Some commodity prices are influenced by the surprise element in macroeconomic news, with evidence of a pro-cyclical bias, particularly when we control for the effect of the U.S. dollar. “Commodities tend to be less sensitive than financial assets—for example, crude oil, the most actively traded commodity futures contract, shows no significant responsiveness to almost all announcements. However, as commodity markets have become financialized in recent years, so their sensitivity appears to have risen somewhat to both macroeconomic news and surprise interest rate changes” (IADB 2009).

Another study done on the relation of macroeconomic events and the determination of commodity prices is by Scott W. Barnhart on “The Effects of Macroeconomic Announcements on Commodity Prices”.  The purpose of this article is to analyze the market reactions of a representative sample of commodity price series and two short-term interest rates to the unanticipated components of thirteen macroeconomic announcements. The analysis of short run impact on macroeconomic events can be used to determine which, if any, macroeconomic shocks have significant effects on commodity prices (Barnhart, S. 1989)

“The announcements considered in this article consist of four monetary variables: the money supply (Ml), net free reserves and the Federal Reserve discount and surcharge rates; two measures of inflation: the CPI and the PPI; six cyclical announcements: the unemployment rate, the industrial production index, consumer installment credit, manufacturers’ orders of durable goods, housing starts and retail sales; and the trade deficit” (Barnhart, S. 1989)

The regression analysis was conducted. It was conducted in an efficient markets framework; also it was similar to other announcement studies, in which the particular announcement is decomposed into its unanticipated and anticipated components. It was believed that in an efficient market only the unanticipated component of the announcement had an effect on the price of the commodity because the anticipated component should already be dis-counted. Barnhart has investigated the efficiency of commodity prices with respect to the unanticipated and anticipated components of a number of the same announcements con-side red here.

“That analysis, consistent with the findings of other announcement papers, revealed relatively minor departures from the efficient markets paradigm. Therefore, the impact of only the unanticipated components of the announcements will be considered here. The analysis is performed by regressing the percentage change in the jth commodity price on the unanticipated component of the ith announcement “(Barnhart, S. 1989).

The specific regression model used is (1) AP, = a,0 + aoX’t + E•t. i=1

The recent developments in the commodity markets include the decrease in the prices of non-oil commodities in past decade. By mid-1993, the relative price of non-oil commodities had declined 42 percent relative to 1980, and 63 percent relative to its peak in early 1974. The decline in the prices was accompanied by the increase in the imports of non-oil commodities by the industrial countries and since 1983 it has doubled while the GDP of these countries has only increased by 30% only. This large increase in the volume of commodity production and trade points to the importance of supply-side factors in explaining price developments. Many factors explain this increase such as technological advancement, agricultural policies by the industrial countries, adjustment of the balance of payments and structural reforms brought by the developing countries. Since 1990, a second major shock has affected commodity markets, namely, the aftermath of the collapse of centrally planned systems in the countries of Eastern Europe and, particularly, the former Soviet Union. So inclusion of the European countries can significantly change the behavior of demand and supply of commodities.

Therefore these facts provide the clues that the commodity prices were influenced by the macroeconomic conditions of that time but we cannot ignore the supply effect also. Hence a supply variable should also be included in the determination of the prices of the primary products (Borensztein, E. and Reinhart, 1994).

 

According to the Trade and Development Board the thoughts about recent commodity market development trends and challenges are that the commodity prices tend to shift in series that are connected with modifications in aggregate demand in the world commodity prices which is high. After some time of a steady turn down from 1995 to 2002 period, international commodity values has been reversed the course, after experienced a sustained increase in 2002, to rise to a level unprecedented in the first half of 2008. On the other hand, since mid-2008, the prices of commodity have fallen piercingly reversal of up to date trends. This surroundings Note, factors that reviews the current developments in commodity markets highlighting, affect the supply short-and medium-term price trends, and demand, areas such as metal agriculture, forestry, fisheries, energy, minerals and development pattern of trade in. In addition, it identifies some of the key challenges developing countries that depend on commodity facing.

According to United Nations Conference on Trade and Development Product structure and trade volume of merchandise in the state, to resolve the exposure to fluctuations in commodity worth. Fuel in addition to base metals, has driven storage bin of exports and imports of main goods of the country in which fatigued in the 2010-2003 era for a good number of countries, the recent volatility. Main industrialized countries shared potential likelihood that food prices carry on to increase which is high, but cannot make up for a turn down in relation with the enlargement of summative command steadily investment boom of China’s commercial real estate and infrastructure is far above the ground which suggests downside risks important price trends of future enlargement performance which calms and is widely expected to carry on, and energy and base metals. It can be observed from the mid-2000s, the rise of prices worldwide manufacturing, will be composed the speed well, price movements in the worldwide trade configuration to below the conditions of trade of commodity exporting country immediately comparable to those after World War I, in a time in the early 1980s; it was thought that it may cause a change. The understanding of the past, price shocks of the exterior, give you an idea about the turn down of an unexpected, mainly in the terms of trade, it would upshot in a downside risk to the economic intensification of commodity exporters, price trends such, many case, the guide jet short-term growth of commodity-based collapse.

 

Research Questions:

Primary Question:

What is the Influence of Macroeconomic Developments on Determination of Commodity Prices?

Research Design:

We will do the descriptive research as well as the explanatory research to find out the research as to know the answers of the questions that what is going on? And why is it going on like that? This will help us to find out the information more clearly. We will be also studying case studies and making statistical data analysis to make our research more effective.

 

Data collection and analysis: 

We will be taking a survey within the sample size of 50 people, those people will be the once who have an idea about the topic that is being researched so that we can get a clear perception about the result.

 

Ethical:

The questionnaire will be conducted from 50 people who might include the students in the respective field and the teachers or professors who have knowledge about the topic and hence answer accordingly. The identity will be safe; people will not have to give their names or any other personal information other than their qualification and age. The respondents will be told that they need not to worry about any kind of reviews that they provide hence they can open up freely.

Research Objectives:

 

            The purpose of this paper is to find the main fundamental economic factors that influence the commodity prices. As we see in the literature the traditional approach is to establish the link between the two using the demand factors but in this paper we extend our approach by incorporating commodity supply in the analysis, capturing the impact on prices of the sharp increase in commodity exports of developing countries during the debt crisis of the 1980s.

Framework:

            We assume that there are three countries in which two countries are the commodity importers and the other is a developing commodity supplier. We first compute the demand for the commodities. The demand for commodities is usually formulated as the demand for an input that is used for the production of final goods. Two countries demand commodities as inputs: the United States and an aggregate of the rest of the industrial countries. After careful consideration we derive our final demand equation as follows

M*(y*, q, R, *) = yA*q*a-l R*a-l    *

Where

= contribution of other inputs to cost and is given by the product of functions of their real prices

q is the price of non-oil commodity inputs relative to the price of U.S. output, and A is a constant (Borensztein, E. and Reinhart, 1994)

 

Now we derive our supply of the two set of the countries. Since countries have vast diversity in their economic structure and production therefore we can write that commodity prices would be determined by equalizing the supply and demand of two countries.

Q = M + M*.

The final equation comes out to be

logq = K +(1/1-a) logIPW – (1 – X) logR – (1/1-a) logQ,

where log IPW = X logy + (1 – X) logy* represents the aggregate level of production in the two countries (the acronym standing for world industrial production), and K includes constant terms and terms in the other factors of production (Borensztein, E. and Reinhart, 1994)

Empirical analysis and Results:

 

            When the effect of macroeconomics events were calculated on the prices of commodities using the demand approach it came out that the exchange rate and the commodity prices were lined together. Dornbusch estimated this link by using the following equation.

qt = 3o + 3lIPW, + 32R, + Ut,

The results showed the coefficients of production and exchange rate to be 2.25 and -1.5. Although the signs are as anticipated, these estimates, as Dorn-busch relates, are troubling. Specifically, commodity prices appear to be excessively sensitive to fluctuations in the real exchange rate. As shown in the previous section, the elasticity of commodity prices with respect to the real exchange rate that clears the commodity market is given by -(1 – X), which is between zero and one in absolute value. If the two commodity importing countries (or blocs of countries) are equal in size and share the same technology, we would expect a value closer to -0.5 rather than the -1.5 found. Therefor if we estimate our above equation by the OLS it leads to simultaneity bias. Hence the demand approach to establish the link between the price of commodities and the macroeconomic events has problems and gives bias results (Borensztein, E. and Reinhart, 1994)

 

Hence we turn to the supply expansion to obtain better results. To proxy for supply developments, we incorporate the volume of primary commodities imported by the industrial countries as a determinant of the price equation. The equation was

qt = Po + 1lIPW, + ,2Rt + 33Qt + ut

When this equation was estimated using the using quarterly data for 1971:-1992 we obtained satisfactory results. First, the coefficient on the supply variable has the correct sign (indicating that an expansion in supply, other things being equal, reduces commodity prices) and the relationship is statistically significant. The supply coefficient at -0.9 suggests that an increase in commodity supply translates to an almost proportional decline in its price, which is in line with the general view that the demand for commodities is inelastic.

Now from the above estimation we can now establish and tell that what made the prices fall in that period. It can be now clear that supply shocks account for about 40 percent of the explained variance for 1971-84, but this share rises to over 60 percent during 1985-88. Also the real exchange rate of USA fairly explains a stable portion of the variance in the commodity prices. (Borensztein, E. and Reinhart,) 1994

 

Further Research:

The above analysis opens many research avenues in this field. Since China is a major world producer so incorporating China and other newly industrializing countries would be highly desirable. Further there are many agreements in the international market on the commodity prices that significantly weakened the prices in 1980s and 1990s. Therefore these agreements should be included in the research to obtain better understanding of the factors.

References:

 

  1. Barnhart, S. (1989) The Effects of Macroeconomic Announcements on Commodity Prices.American Journal of Agricultural Economics , 71 (2), p.389-403. Available at: http://www.jstor.org/stable/1241597 [Accessed: 26th april 2013].
  2. Borensztein, E. and Reinhart, . (1994) The Macroeconomic Determinants of Commodity Prices.Palgrave Macmillan Journals on behalf of the International Monetary Fund, 41 (2), p. Palgrave Macmillan Journals on behalf of the International Monetary Fund. Available at: http://www.jstor.org/stable/3867508 [Accessed: 26 april 2013].
  3. IADB (2009)The Effects of Economic News on Commodity Prices. [online] Available at: http://www.iadb.org/intal/intalcdi/pe/2009/03913.pdf [Accessed: 26 Apr 2013].
  4. RBA (2009)Determinants of Agricultural and Mineral Commodity Prices. [online] Available at: http://www.rba.gov.au/publications/confs/2009/frankel-rose.pdf [Accessed: 26 Apr 2013].
  5. Trade and development board (2009) Recent commodity market developments: trends and challenges [online] Available at: http://unctad.org/en/Docs/cimem2d2_en.pdf [Accessed: 26 Apr 2013].
  6. United Nations Conference on Trade and Development (2012) Excessive commodity price volatility: Macroeconomic effects on growth and policy options [online] Available at: http://unctad.org/meetings/en/Miscellaneous%20Documents/gds_mdpb_G20_001_en.pdf [Accessed: 26 Apr 2013]

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