Why a commodities boom?

Inflation from the UK has been published at 3.8% for 2010, not especially high but greater cost push inflation seems set to come at least after booming commodity prices, the highest since the elevated levels of 2008 and we must think of the low income groups around the world who are not in conditions to grow their own produce. I will look at what the likely causes are of the commodities spike.

What Commodites?

Pretty much all raw materials from the earth or grown have become more expensive. To look at some, sugar is at a 30 year high, oil is nearing $100 a barrel and at its highest level since its crazy heights in 2008, Coal has risen due to the Queensland floods, Cocoa is up 12% so far in 2011 not to mention precious metals(although gold and silver rises less affect the typical basket of goods).

Possible Causes…

Quantitative Easing

One of the major links I can think of is Quantitative Easing by the US and UK central banks in the midst of the financial crisis, followed by the open market operations through the buying of securities to try to stimulate the economy. The link is that the buying inflates general asset prices and causes a fall in bond yields and long term interest rates. This further drives up equities and other investments, including commodities which now look relatively more attractive with such low long term rates. More money in the system acts as a catalyst.

Copper, a crucial element for wiring is one of the many at a high

The QE and global financial crisis also has caused less confidence in the currency, especially during the thick of it which can see fearful investors going into something which will always have a value, particularly gold, which is one of the reasons why that itself, and silver has risen so sharply.

Emerging Economies

The Brics and others like Turkey and Eastern Europe are taking on huge scale manufacturing projects usually driven by non domestic companies, and, with a rise in living standards causing more consumer durables spending it is plain to see the world intake of commodities as inputs or energy will rise. In still erratic conditions in the developed world, emerging economies are still growing at about 10%, a doubling in income every 7.3 years at current rates!

Also, these countries often have fast growing populations leading to rising food demand. Not only this, but many are escaping poverty too thus leading to world food demand to grow even faster.

World Recovery: This is strongly linked to the world economic recovery, notably in the US, the (as of now) worlds biggest final consumer, driving demand.

Natural Disasters

These seem to have become more frequent and its not only due to just news broadcast globalising. The floods in Pakistan and Australia, the Haiti earthquake. Quite a shocking statistic below quoted from the UNEP website, especially the rise in floods reported. To note, a great majority of natural disasters take place in the less developed nations for which the mining and growing of commodities is what they specialise in. This has obvious implications of restricting supply, and has been a major reason for rising coal and food prices.

Trends in natural disasters (map/graphic/illustration)

The Growth in ETFs.

Some exchange traded funds have exposure to commodities and the investment is linked to the prices of a basket of them. ETFs generally buy futures contracts of various commodities, and the pooling of capital into these ETFs can cause price pressures. Commodities linked funds are becoming ever more popular at attracting investors, possibly a contributing factor, albeit more minor than the above.

Be set for further price rises in retail, although these cannot be too high due to the oligopolistic nature of this market. Profitability of supermarkets and product business brands such as Unilever and Kraft are likely to be hurt.

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