Thursday, June 11, 2009

Commodity Prices Lie

Commodity prices have been soaring since March. During a recession, it is unusual for commodity prices to rise to such relatively high levels, as demand usually drops, resulting in an overcapacity of supplies causing downward pressure on prices.

So why are prices rising this time? If supplies are currently inadequate, one would expect strong growth in supply production, which should help create employment in an otherwise poor job market.

Thanks to some terrific research by Macro Man, we can see one reason commodity prices have been rising: China is buying more than it needs. The following illustrates this phenomenon by showing China's volume imports for copper, iron ore, and coal over the last several years:

Macro Man's conclusion, which appears to be supported by the evidence above, is that China is stockpiling inventory at cheap prices (cheap relative to one year ago, that is). So while the run-up in prices may cause some to believe that demand is back, it may actually be a warning sign that future demand will drop even further, as the excess inventories China is building up will need to be worked through.

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