No sign of overcapacity yet as global commodity prices come off peaks

The exception is energy, which isn't dictated by liquidity conditions, but by decisions of the Opec-plus cartel, where plenty of other factors come into play

The big set of data points the monetary policy committee of the Reserve Bank of India explored this week was about whether the global spiral in commodity prices had begun to ease off. The call on when the markets in India would come off their highs depended pretty much on reading these emerging trends correctly. 

While analysts had begun to notice some softness in global prices, what has not been adequately commented on is that prices had begun to harden from the middle of last year, once the world began to brush off Covid risks.

As of now, the widely-tracked Food and Agriculture Organization’s global Food Price Index  has averaged 157.4 points in May 2022, down 0.6 per cent from April. This is the second consecutive month when the index has declined. Safety is still far away though. Year on year, the index for May 2022 is 22.8 per cent above the value in the corresponding month of last year. The FAO website notes, “The drop in May was led by declines in the vegetable oil and dairy price indices, while the sugar price index also fell to a lesser extent. Meanwhile, cereal and meat price indices increased.”

The broad numbers could therefore be gloomy or bright, depending on one’s position in the market. The Bloomberg Commodity Total Return Index is at 44.61 per cent for the year to date. This is way above any percentage returns achieved in any recent years. 

Looking at the FAO data it is, however, clear that the general global food price index had begun to climb from July last year when it was 124.6. By December 2021, the index was up 7.3 per cent. Naturally, all the constituents of the index, dairy, cereals, vegetable oils, sugar and meat had followed the trend (see table). 

What about metals? The S&P GSCI Industrial Metals index showed a trend similar to that of the food prices from last year, but with a  delay. From mid-August till the middle of October 2021, the broad base metal price index had risen 18.8 per cent. It did come off somewhat lower in mid-December, but still quite above the lows of August. 

The index peaked in March this year. It has since retraced by 17.96 per cent as on June 6. The blip is that the downward movement isn't yet firmly established. Of particular concern is aluminium, whose three-month forward contract indicates hardening of prices again. Year to date, the index has offered a return of 3.49 per cent. When one compares it with the returns of 5 year at 10.69 per cent, there is clearly a lot of juice still left in the pipeline. 

The big concern in the global commodity market is simple. The high exchange rate of the US dollar against other currencies is a major cause for worry.. Usually spells of high commodity prices have been periods of low dollar valuation. In this round, that equation has broken, making the balance of payments crisis more sharp. Also while supply shortages have begun to ease because of smoother movement of most commodities, the hold-out is of energy prices. Liquidity concerns in global markets do not impact energy prices, chiefly oil and gas, as these are impacted by decisions of the Opec-plus cartel, where plenty of other factors come into play.

Jeremy Weir, CEO of global commodity trading company Trafigura, told Financial Times this week that he expects oil prices to start climbing from now on to $150 a barrel, on the back of renewed demand from China before slumping to a low by the end of the year. The anticipation of these trends has already made oil prices rise again. Saudi Arabia raised oil prices for the Asian market “by more than expected”, a Bloomberg report noted, to over $120 a barrel this week, anticipating reversal of Covid-induced lockdown in China and Singapore. The continued shortage will not ease till there is a rebalancing of the global demand and supply markets amid the new political equations. 

But for other commodities, including edible oil which is a big part of exports and imports in Asia, the process of easing up has accelerated because the central banks are absorbing liquidity in a big way from the markets. 

Saugata Bhattacharya, EVP and chief economist, Axis Bank explains how significant liquidity is in pushing up inflation, He calculates that in India the markets can absorb liquidity of Rs 2.6 trillion without spurring inflation. “Every one percent addition beyond this leads to a further 60 bps of inflation over the course of a year”, it notes. The current level of liquidity in the Indian market is an average of Rs 3.7 trillion, quite some way off from the non-inflation range. Once the RBI follows through with more jumps in cash reserve ratio to be held by banks, the liquidity and therefore inflation will ease, he feels.

Strong evidence of a sustained easing of commodity prices can be seen in global shipping rates. The bellwether Baltic Dry Index had risen by two thirds in a little more than a year from last April to its peak in late May this year. Those rates have eased by as much as 24 per cent in less than a fortnight. Not surprisingly, the downturn in global economic growth prospects has improved the supply position in various industries. The most glaring example of this is the automotive sector where the global semiconductor shortage, which again precedes the Russia-Ukraine war by at least a year, is “showing signs of easing”, according to a report by <Automotive News Europe> (https://europe.autonews.com/automakers/automakers-feel-chip-crisis-easing-global-growth-slows). Over capacity may still be a long way off for the global economy, but the peak of commodity shortage is clearly over.   

Table: How the commodity indices moved

Period	FAO General Food Price	FAO Dairy	S&P GSCI Industrial metals*
June 2021	125.3	119.9	480.27
July 2021	124.6	116.7	477.10
August 2021	128,0	116.2	471.10
September 2021	129.2	118.1	469.16
October 2021	133.2	121.5	486.19
December 2021	133.7	129.0	499.08
March 2022	159.7	145.8	586.13
April 2022	158.3	146.7	541.82
May 2022	157.4	141.6	508.21

*End-of-month values

Table: Baltic Dry Index

April 11, 2022	2,035
May 23, 2022	3,369
June 7, 2022	2,514