The Relationship Between Monetary Policy and Commodity Prices

by: Calafia Beach Pundit

The extreme volatility of industrial metals prices in the past two years compels me to feature this chart, which shows the metals subindex of the Journal of Commerce commodity index. Since the end of the 2001 recession, industrial metals prices have risen fully 250%, yet they are still 23% below their high of April '08.

Other important observations: It cannot be a coincidence that the long slide in commodity prices which started in 1996 and ended in Nov. '01 occurred during a period in which U.S. monetary policy was unusually tight. This shows up in the second chart as a real Federal funds rate that averaged about 4%. During this same period, the U.S. economy was for the most part unusually strong. Since 2001, monetary policy has been erratic but generally accomodative, while the economy has not been particularly strong, and in fact suffered one of its most painful recessions. Yet commodity prices have surged.

The conclusion I draw from this is that monetary policy has had a very important influence on commodity prices. As long as monetary policy remains accommodative, commodity prices are likely to continue to rise, especially if the U.S. and global economies continue to gain strength. Commodity prices are not yet in bubble territory, by my estimation, but they could well be the next bubble to form.