THE SAD TRUTH ABOUT REAL COMMODITY PRICES

by PETER ABELSON *

“Commodity surge just in time for election”, Australian Financial Review,

“Australia gets a lucky break”, Sydney Morning Herald, 4 April 1989. Commodity prices are indeed crucial to the Australian economy. Although

the government has pursued a restructuring program for several years, commodities still make up 84% of all merchandise exports.

Despite a boom in tourism, commodities make up 71% of all trade in goods and services (which amounted to $41.5bn in 1987-88).

Readers of the Australian Financial Review (AFR) and Sydney Morning Herald, especially investors, will doubtless have felt much happier after reading the almost euphoric headlines and accompanying articles that greeted the latest forecasts of commodity exports published by the Australian Bureau of Agricultural and Resource Economics (ABARE, 1989a).

According to the leading story in the AFR, the Bureau was forecasting “a very strong rise in export prices and a 10 per cent lift in commodity exports in 1989-90”. This may well have given a misleading impression.

What the Bureau actually predicted was a 3% rise in the volume of commodity exports in 1989190, a 7% rise in export prices (in A$s) and a 10% rise in the total value of commodity exports. In itself this is hardly a bonanza. Import volumes for all goods and services have recently been rising at well over 10% per annum and domestic prices have been rising at around 7% per annum.

It is true that commodity prices have risen sharply in the last two years, even in real terms, and there may be some relief that these prices are expected to stay firm. But, as we will see, the sad truth is that both present and (ABARE) forecast real commodity prices are well below real commodity prices in the 1970s and early 1980s.

One of the problems with most discussions of commodity prices is that most published commodity price indices are nominal indices which make no allowance for inflation. For example, a recent article on commodity prices published in the Reserve Bank’s Bulletin (Horton, March 1989) analysed in some detail the relationship between nominal commodity prices and economic activity.

29 March 1989.

* Macquarie University. Presidential Address to the Economic Society of Australia, NSW Branch.

92

A second problem is that only a few indices are measured in SDRs or some such international currency unit that is independent of changes in individual currencies. This is a particularly important problem in the Australian case, since the value of the A$ has halved since the mid 1970s.

A third problem is that popular opinions on commodity prices are often based on price movements over a comparatively short period of up to five years.

This paper aims to overcome each of these problems.

Data This paper is based on three main sets of data:* Macrodata. This set includes inflation rates for the A$, the US$ and for the OECD, the TWI of the A$, price indices for major groups of Australian commodities (rural, non-rural, total] and price indices for world commodities (a non-energy index and petroleum prices]. Price data for the most important Australian commodities. These include wool, wheat, beef, coal, aluminium, iron ore and gold. As shown in Table 1, these commodities are responsible for a very large part of the weights in the Reserve Bank's indices for rural and non-rural commodities respectively. Data for other important Australian commodities. These include most of the other commodities shown in the table below plus rutile, zircon and uranium.

TABLE 1 WEIGHTS IN RESERVE BANK INDEX

Rural Commodities Non-rural Commodities

Wool Wheat Beef Sugar Cotton Barley Rice Sorghum Butter

20.2% 9.6% 8.6% 3.2% 1.7% 1.1% 0.3% 0.3% 0.2%

Coking coal Steaming coal Iron ore Gold Aluminium Crude oil Lead Zinc Copper Nickel

15.0% 8.6% 7.6% 7.2% 7.1% 4.4% 1.9% 1.3% 1.1% 0.6%

Total rural 45.2% Total non-rural 54.8%

Where possible, I collected data for the period from 1960 to 1988, but some data were not available for the full period. More data were available for calendar years than for financial years. When only financial year data

* A full data set is available from the author.

93

were available, these data were collected and used to develop calendar year data.

In addition I drew on the ABARE’s forecasts of rural commodity prices to 1993 (ABARE 1988), and its forecasts of non-rural commodity prices to the year 2000 (ABARE 1989b).

Analysis of Data The analysis consists of three main steps: All commodity price series are converted into nominal indices (with 1988 = 100). The nominal price indices are converted into real price indices (1988 = 100) with the use of an appropriate inflation index. For example, the SDR indices are converted into real indices using the OECD inflation index. The real price indices are expressed in terms of international currency values. In case of indices that were originally in A$, I converted them into an international currency equivalent by multiplying them by the TWI (1988 = 100)/100.

Results World Commodity Prices

In the ten years to 1988, world non-energy commodity prices fell by nearly 50% in real terms (see Graph 1). Over the last five years, world non-energy commodity prices have fallen by about 25% in real terms. Note that 1988 was not by any means a particularly bad year for commodity prices since

WORLD REAL COMMODITY PRICES 1971 = 1w

IMF NON-ENERGY 100 - - q X

0 1 / 1 1 1 1 1 / 1 1 1 / / 1 1 / / 1 1 1 1

1971 1974 1977 1980 1983 1986 1989 1992

94

they had recovered significantly over the previous two years. Nevertheless, at these rates of decline, world non-energy commodity prices have been falling by around 5% a year in real terms.

Petroleum prices have been much more volatile and therefore the change in price depends crucially upon the reference point. However, as a generalisation, it may be observed that petroleum prices have fallen by one- third in real terms since the mid 1970s and they have halved in real terms during the 1980s.

Australian Commodities Although Australian commodity prices have increased in real terms by

about one-quarter in the last two years, Graph 2 shows that measured in SDRs they are still one-third lower in real terms than they were through most of the 1970s and the early 1980s.

The fall in non-rural prices has been particularly marked. In 1988, in terms of international purchasing power, non-rural commodity prices have fallen in real terms by over 50% since the mid 1970s, and by about 50% since the early 1980s. In international currency values, Australian rural commodities have fallen by about one-half since the mid 1970s and by around 20-30% since the early 1980s.

Of special interest are the forecast real indices for Australian commodities. As noted, these are based on ABARE price forecasts.

1971 = 100 AUSTRALIAN REAL COMMODITY PRICES

1971 1974 1977 1980 1983 1986 1 989 1992

95

Notwithstanding the bullish nature of much commentary on Australian commodity prices, in international currency values all these indices (rural, non-rural and total) would be much lower in 1993 (as indeed they would be in 1989 and 1990) than they have been historically.

Table 2 shows the declining real price trends (in international currencies) for major Australian commodities. In my view it is unlikely that we shall see significant real increases, if any, in coal, iron ore or gold prices in the medium term. The real wool price will probably fall from the very high levels in 1988. The price prospects for wheat and beef appear reasonable, though no “El Dorado”.

Since the mid 1970s there have also been major declines in the real prices of other rural products (barley, sugar, cotton) and non-rural products (copper, lead, rutile and uranium). Only a few commodities (eg, zinc and zircon) have defied this general trend.

Conclusions During this year the NSW Branch of the Economic Society was fortunate

to be addressed by two leading experts on commodity prices: Mr John MacLeod, Senior Economist at CRA and the President of the Australian Economic Society, on “Mineral Prices”, and by Dr Gus Hooke, Chief Policy Adviser of the National Farmers’ Federation, on “Rural Commodity Prices”. Both were remarkably bullish about commodity price prospects although they did not give precise forecasts.

John MacLeod observed that stocks of minerals are currently very low: that there have been few major investments in mines anywhere in the world over the last few years: that much of the production of minerals is in developing countries which have problems in providing reliable supplies; and that environmental constraints were affecting the establishment of new mines.

Gus Hooke based his optimism about food prices on the fast growing newly industrialised economies of South-East Asia which are likely to have high demands for food; and on the enormous potential of the China market because of its huge population.

In my paper I have drawn on ABARE forecasts of commodity prices. ABARE is, of course, not unaware of, or unsympathetic to, the factors that influence the MacLeodlHooke views of the world. Nevertheless, my paper finds that when the allowances are made for inflation and for currency changes, both present and forecast commodity prices are well below those of the 1970s and early 1980s.

The picture that emerges is not a very happy one. I for one would not like to see the Australian economy attempting to ride on the back of the manufacture and service sectors. I would like to think that the MacLeodlHooke scenarios are correct-I fear, however, that they may not be.

96

TABL

E 2

Yea

r W

ool [

grea

sy]

Whe

at

Bee

f C

okin

g co

al

Stea

min

g co

al

Alu

min

ium

Ir

on o

re

Gol

d M

AJO

R A

UST

RA

LIA

N C

OM

MO

DIT

IES:

REA

L IN

DIC

ES (1

988

= 10

0) - IN

TER

NA

TIO

NA

L CU

RREN

CIES

Auc

tion

av.

Av.

exp

ort

Sale

yard

A

v. f

ob

Av.

fob

LM

E av

. A

v. e

xpor

t LM

E av

. va

lue

pric

e C

al. y

r C

al. y

r va

lue

Cal

. yr

~ ~

1960

19

61

1962

19

63

1964

19

65

1966

19

67

1968

19

69

1970

19

71

1972

19

73

(0

1974

u

1975

19

76

1977

19

78

1979

1980

19

81

1982

19

83

1984

19

85

271.

5 19

5.3

61.0

58

.8

57.3

175.

3 16

3.3

169.

6 19

3.5

190.

1 17

1.8

164.

4 14

6.0

323.

0 32

3.6

318.

0 31

9.0

314.

6 30

5.3

305.

2 29

0.4

267.

2 25

7.1

250.

0 23

8.7

245.

6 43

9.1

561.

9 43

7.9

313.

2 24

5.4

246.

1 27

5.8

278.

1 25

8.9

249.

4 22

0.5

194.

9 16

5.1

111.

3 88

.5

100.

0

187.

7 18

0.8

171.

4 20

1.1

200.

7 23

0.2

279.

2

~ -~

17

2.2

180.

9 18

1.1

174.

2

57.5

57

.2

55.9

53

.7

181.

3 17

6.2

171.

4 16

4.3

269.

9 26

6.6

262.

4 25

0.7

251.

7 24

8.5

241.

8 32

1.7

169.

0 16

7.7

173.

8

176.

3 17

0.4

145.

4 12

7.2

151.

6

52.2

57

.1

58.8

13

7.1

127.

1

100.

5 91

.4

163.

3 23

5.1

184.

0 13

3.8

132.

7 12

2.1

107.

3 11

0.2

155.

7 14

5.2

49.4

53

.3

70.0

13

7.3

151.

6 16

5.6

99.2

14

8.8

205.

8 93

.1

101.

0 15

4.1

139.

5 16

0.8

168.

1 15

7.0

169.

2

137.

9 94

.1

99.5

10

4.7

94.2

11

1.3

218.

9 26

5.1

241.

9 19

7.6

187.

3

209.

1

149.

6 16

6.9

170.

5 11

2.2

88.0

12

3.1

94.5

83

.9

75.2

84

.1

100.

0

166.

6 16

9.2

181.

2

152.

9

279.

2 19

7.7

161.

6 17

3.9

132.

5 12

0.8

115.

5 11

5.1

100.

0

115.

5 11

3.6

102.

5

202.

5 16

7.1

235.

7 24

2.5

247.

0

_.~

~

256.

8 26

5.9

-~ ~

172.

0 18

2.6

151.

0 13

4.2

152.

0 14

7.1

124.

8

92.1

87

.3

77.8

68

.5

81.9

100.0

222.

4 19

6.4

173.

6 14

0.7

109.

8 10

0.0

224.

1 19

0.2

166.

5 13

3.8

104.

4 10

0.0

128.

2 12

4.5

115.

9 10

8.0

100.

0

1986

19

87

1988

100.

1 92

.0

100.

0

Fore

cast

19

89

116.

6 11

3.0

118.

5 13

8.6

107.

3 10

9.2

107.

0 10

9.3

106.

8 10

0.3

88.9

n.

a.

113.

0 10

9.4

105.

7 n.

a.

119.

5 12

5.7

94.3

n.

a.

108.

1 10

6.7

106.

9 11

4.5

90.7

88

.7

112.

4 12

0.0

120.

0 12

3.4

1990

19

93

2000

77

.1

74.3

Sour

ces:

His

tori

c dat

a w

ere

take

n fr

om C

omm

odity

Sta

tist

ical

Bul

letin

. Dec

embe

r 19

88, A

ustr

alia

n B

urea

u of

Agr

icul

ture

and

Res

ourc

e Ec

onom

ics.

For

for

ecas

ts p

rice

s, s

ee r

efer

ence

s in

text

.

REFERENCES Australian Bureau of Agriculture and Resource Economics, 1988, Quarterly Review of the

Australian Bureau of Agriculture and Resource Economics, 1989a, Agriculture and Resources

Australian Bureau of Agriculture and Resource Economics, 1989b. Outlook for Australian

Horton, T., 1989, “World Commodity Prices during Economic Expansions”, Bulletin, March,

Rural Economy, 10 (4). December, Canberra.

Quarterly. 1 (l), March, Canberra.

Minerol Resource Exports to 2000.

Reserve Bank of Australia, Sydney.

98