Commodity price trends are a hot topic among some of my clients and audience members. This is the first of three articles about commodity price, covering basic material that someone buying or selling commodities should understand. The need for the information goes well beyond the trading desk of a broker, however. Plenty of sales people and purchasing managers should understand commodity pricing, even if commodities are only a small part of the day's work. Further, anyone whose company is heavily dependent on some commodity should understand that commodity very well. The product may use copper or cotton, leather or lead. In any case, understanding how commodity prices change will help you buy or sell whatever your company is involved in.
Commodity Basic Fact #1: Commodity prices are more variable than overall prices.
The chart below compares changes in the CRB commodity price index with changes in the U.S. Consumer Price Index. The CPI sure looks stable when plotted against commodities. The next article will help explain why commodity prices sometimes shoot up, why they stay up for a while, and why they then come crashing down. It's a dramatic story, so you may want a check with your doctor before reading it.
The CRB index is a composite of a number of different commodity prices. As such, it is more stable than any one of its components. So the more specialized indices, such as for metals, is even more volatile. And then any particular metal will have even more volatile prices than the index. So for any basic material, expect far more price variation than in the overall economy.
Commodity Basic Fact #2: Commodity prices rise less than overall prices, on average.
Since 1950, the average annual increase in the CRB index has been 2.5 percent, compared to 3.7 percent for consumer prices. That's a huge difference when you consider compounding. Over 63 years, the CPI has risen to ten times its starting value; the CRB to just five time its starting value. This is despite a rising population and rising global standard of living that has us consuming more stuff.
It turns out that of all the things that humans do, processing commodities is something we've gotten much better at. We pump oil more efficiently, we mine ores more efficiently, we grow grains more efficiently. We're not much better at cutting hair or pouring a glass of beer or doing many of the things that are part of the service economy. But we're pretty good- and getting better- at producing commodities.
We're also better at finding substitutes. When whales were over-caught, whale oil became more expensive. We developed petroleum. Plenty of plastic objects were at one time made of steel. Saw mills can now cut veneer much thinner than ever before, meaning that it doesn't take much wood to dress up an otherwise ugly sheet of plywood.
This lies behind the famous bet between Paul Ehrlich and Julian Simon. Ehrlich, author of The Population Bomb, believed (and maybe still does) that rising population would cause shortages of critical commodities. Simon, an economist, saw productivity increasing faster than demand. He bet Ehrlich that five commodities (selected by Ehrlich) would fall in price. Ehrlich thought they would rise in price. Ehrlich lost and paid up.
Now let's go really far back. In the era from 1800 to 1810, wheat ranged in price from $1.00 to $1.84 per bushel. Most recently it sold for $6 to $8. Note that since 1800, the Consumer Price Index is up by a factor of 14. So wheat has not come anywhere close to keeping up with the CPI.
Copper sold for $9.50 at its low, $11.65 at its high in the early 1800s. Now it trades at $3. It not only didn't keep up with inflation, it didn't even stay level in nominal terms.
Steel nails sold for about $10 per 50-pound bag. I'm not sure the actual size and grade of nails back then, but an online source shows that I can buy 50 pounds of steel nails for $12.50. That's negligible inflation over more than two decades.
(These delightful statistics are from Historical Statistics of the United States, Colonial Times to 1970.)
Some commodities have probably gone up in price by more than inflation, but as a general rule, look for commodities to rise in price more slowly than overall prices-but with much more variability.