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September 9, 2004

Copper reputed to have PhD in economics because of past forecasts

Resource prices pointing to global moderation

BY STEPHEN

S. POLOZ

(DCN SPECIAL)

With high oil prices in the news every day, it is no wonder that other resources have had to take a back seat.

But commodity prices appear to be peaking, pointing to a moderation of global growth.

Non-energy commodity prices as a group (including such materials as copper, aluminum, nickel, zinc, gold, silver, pulp, paper, lumber and various agricultural products) have risen by about 50 per cent from their late-2001 lows.

This rapid move caught a lot of attention early in 2004, as analysts pointed to China’s seeming insatiable demand and warned that more price rises were in store.

But serendipity struck just as this story hit the wires, with the Chinese authorities announcing that they would be taking action to slow their economy to a more sustainable pace.

Meanwhile, U.S. economic statistics turned south, underscoring the view that demand for resources was slowing.

As with most swings in economic sentiment, the subsequent drop in resource prices during late spring was probably overdone, and they have rebounded this summer as if to prove the point.

Doubts have now emerged about the effectiveness of China’s efforts to slow their economy, and a scattering of better economic reports suggest that the U.S. economy remains solid.

Accordingly, many commodity prices have worked their way back up to around their spring highs.

These short-term price movements can be fascinating for commodity speculators, but a big problem for companies that actually buy commodities for their operations.

Longer-term movements in resource prices are less mysterious—they typically follow the global growth cycle closely.

Previous peaks were in 1988 and 1996, the last two times that the world was firing on all cylinders.

Since late 2001, when prices hit an all-time low amid concerns about global deflation, there has been a spectacular recovery in both the world economy and in commodity prices.

In effect, commodity prices have returned to levels consistent with strong world economic growth.

Consider copper, for instance, which is reputed to have a PhD in economics because of its past forecasting ability.

Copper prices were very depressed from the time of the Asian crisis in 1997 until about a year ago, when they skyrocketed, more than doubling in 12 months.

But all that has happened is that now copper prices are about where they were during 1994-96, and are now exhibiting the typical zig-zag pattern of a major peak—incidentally, the recent up-tick in copper inventories suggests that supply has caught up with demand, supporting this interpretation.

One could interpret gold prices in the same way—gold was around $400 per ounce during 1994-96, then fell below $300 during the next five years of weak global economic growth, and now has returned to around $400.

Same story for zinc. Nickel and silver have also followed similar patterns, although their prices have risen above their past peaks.

The bottom line? Few believe that the global economy is about to fall off a cliff, and neither will commodity prices.

Commodity markets are having trouble finding direction right now, precisely because there shouldn’t be a direction— something more like a plateau is probably in store.

Stephen S. Poloz is the senior vice-president and chief economist for Export Development Canada. spoloz @edc.ca

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