Plummeting Commodity Prices: A Double-Edged Sword for Global Trade

In the latest Commodity Market Outlook, the World Bank further lowers its expectations for 37 out of 46 commodity prices that have been observed. The forecast for crude oil is down to $37 per barrel from $51 in its October prediction, and iron ore is expected to sustain the largest decline.

It is hard not to notice that commodity prices have plummeted since 2014. The Bloomberg Commodity Index BCOM, a broadly diversified commodity price index, has witnessed a drop of over a quarter in 2015, reaching its lowest record since June 1999. As of February 2016, crude oil price has fallen more than 40% for the past year, and platinum and cooper have dropped over 20%. From nickel to soybean oil, plywood to sugar, global commodity prices have been walking on a downhill path.

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World Commodity Prices

Source: World Bank

Behind this massive deflation is a nasty combination of overflowing supply and weak demand worldwide. With annual real gross domestic product growth rate lower than expected, traditionally large consumers of commodities, North America and Europe, are still struggling to release their financial excesses accumulated during the low interest rate period, and their demand for commodity-based products remains weak.

Another strong consumer group of commodities, emerging markets, are making things even worse. From 2000 to 2014, China’s annual GDP growth averaged more than 10%, and during the same period, China’s share of global copper consumption leaped to 43 percent from 12 percent. China’s portion of iron ore purchases similarly zoomed to 43 percent from 16 percent, while aluminum went to 47 percent from 13 percent. However, as predicted by analysts, this will not last forever. Since late 2014, China’s growth has slowed down, and its demand for energy and other commodities has steadily declined. Not only China, other emerging markets, including Brazil and Russia have also seen slowing growth rates, exerting downward pressure to the commodity price. Faced with sluggish global demand, supply, however, does not adjust accordingly. Producers decide not to cut output to keep their market power.

At this moment, commodity price plunge is no secret; the question is, is it good news or bad news for the world trade? Affected by sluggish world economy, global trade volume has been shrinking. Intuitively, falling commodity prices is a double-edged sword. On one hand, plummeting commodity prices may bring down input costs, stimulate world consumption and help pull the world economy onto normal track. For net importers such as the US and India, the price downturn has already helped to decrease production costs, improve infrastructure and revive consumer spending. Moreover, it also gives governments more space to lower interest rates amid slow global economic growth. For instance, Indian government decided to seize the opportunity and increase its import of crude oil for future benefits. Last year, South Korea’s central bank cut its benchmark interest rate to 2%, a move made possible because the low fuel costs helped keep inflation in control.

On the other hand, however, loss of faith in the world economy may lead to deteriorating downturn and restrain consumption. The World Trade Organization has downgraded its global trade forecast from 3.3 percent to 2.8 percent for 2016, half the annual average of 1990-2008. For net exporter countries such as Russia and Saudi Arabia, the negative impact is extremely obvious – it would take a long downturn for them to suffer more and investors are increasingly losing faith in a strong recovery. Take China for example, in 2015, it experienced contraction in both imports and exports, and its GDP growth fell to the 25-year low. For South Korea, low prices give it more space to maneuver in the financial market, but it is also a major exporter of electronics and automobile parts. If crude’s decline turns out to be largely caused by slumping demand in China and Europe, the weak markets over the longer run would hurt Korea’s export industry.

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China Exports and Imports

Source: National Bureau of Statistics

Most analysts, including World Bank and IMF, believe that the price downturn has not reached its bottom. As said before, producers are reluctant to reduce production in spite of falling revenue. As long as market prices exceed marginal cost, more production is encouraged to make up for lost revenue. Some producers will raise output even when prices fall below marginal costs. Therefore, it is expected that the commodity prices will continue to drop in 2016, and no one can say with certainty when the deflation will come to an end.

References:

http://www.bloombergview.com/articles/2015-10-05/oil-and-other-commodity-prices-haven-t-yet-hit-bottom

http://www.cnbc.com/2015/01/06/not-just-oil-are-lower-commodity-prices-here-to-stay.html

http://www.wsj.com/articles/oil-price-slump-is-double-edged-sword-for-asia-1413371611

http://money.cnn.com/2015/07/21/investing/commodities-prices-gold-oil-copper-aluminum/

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