Eddielogic

– Thoughts on Strategy and Management

Commodities as economic indicators

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This is the headline of an article in today’s online version of FAZ.
It is no rocket science and not even a real article, more a slide show. However, the issue is well worth remembering from time to time. This is exactly what I want to do today. So are commodities prices a useful early indicator or not? Based on the well-known facts that are stated in the article, the answer is clearly: yes and no!

Yes!

In theory, industrial metals are a great early indicator for economic development. When the world is going to fall into a recession, demand for raw materials decreases early and prices fall. When major industries are expecting rising demand, their demand for commodities will rise. This is the sound economic connection between demand and prices.

No!

Prices are not only determined by demand. The other side of the economic equation is supply. Natural resources for many commodities are limited and hence, many analysts expect a stable long-term trend for price increases which is independent of short-term economic ups and downs. Besides that, supply of commodities is influenced by many more factors: political situation in production countries, political influence of major consumer countries (e.g. China), technological progress which opens up new resources, or technological disasters, storage volumes, transport capacities and more.

So, the final answer is Yes, however:

Yes, commodities make a good indicator for future economic development, especially if a particular raw material is identified which has ha relevant relationship to a particular industry. However, simple following of price fluctuations has a great risk to mislead to wrong conclusions. If you want to use commodities as an economic indicator, you need to be willing to drill down a bit deeper. For every major price fluctuation you have to identify potential other causes. Only if you can eliminate those, you may conclude about future economic trends.

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