Aurora Borealis
1 November 2013 CFA Institute Journal Review

Shocks and Ores (Digest Summary)

  1. Santosh Pokharel

A recent empirical study considered the price trends of commodities and how prices of different classes of commodities, such as minerals and natural gas or rice and corn, fluctuate over a period of time.

What’s Inside?

Various findings and theories associated with the historical trend of commodity prices are presented. Using a finding from recent empirical research, as well as analyzing how prices of different classes of commodities trend over a period of time, the author argues that short-term fluctuation in commodity prices has a more adverse effect than long-term trends.

How Is This Article Useful to Practitioners?

Although it is a difficult task, almost every investment practitioner aims to understand how commodity prices fluctuate over time and what impact such fluctuations will have on the broader economic outlook. From the time of Thomas Malthus, who predicted (incorrectly) in the late 18th century that population growth would lead to soaring commodity prices, the subject of commodity prices has been a hot topic.

The author summarizes the findings of a recent empirical study by David Jacks, an economist at Simon Fraser University. First, although commodity prices have displayed a clear upward trend in the long run, having risen by 192% since 1950 and by 252% since 1900, this trend has not translated into global famine, as predicted by Malthusians. Second, different classes of commodities have exhibited different price trends. For example, long-run price increases have been most pronounced for commodities that are “in the ground,” such as minerals and natural gas. But prices for commodities that can be grown, such as rice and wheat, have trended downward. The third finding, and the most interesting, relates to commodity price movements in the medium term (over a period of 40 years), which are termed “super-cycles,” and short-term fluctuations. The author notes that in a typical super-cycle, commodity prices tend to deviate at least 20% from the trend. This kind of trending happens in a period of rapid industrialization or urbanization, such as the 1890s in the United States and the 2000s in China.

In the short term, the price movement is more acute and can cause more damage because these short-term boom and busts are also more common. These short-term gyrations can cause price spikes of at least 50–100% away from the growth trend.

Abstractor’s Viewpoint

The author provides an excellent overview of how commodity prices trend in the short and long term and how prices of different classes of commodities trend over time (ex post). What needs to be better established is how these pricing trends can be predicted (ex ante).

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