What is the issue?
- Globally, the prices of commodities are rising or expected to rise.
- This is seen as a sign of a likely commodities supercycle.
- The development is to be understood in view of the relationship between commodities prices and the US dollar.
What is a supercycle?
- In economic terms, a Supercycle is the longest period or wave in the growth of a financial market.
- e.x: In 1700s, due to the Industrial Revolution in Britain, prices of coal, cotton, sugar, tea etc went up and greater quantities were produced.
- But over time, the innovation worn out, demand lowered when supply was growing, and the prices of commodities dropped, causing the end of the super-cycle.
- The last commodities super cycle was roughly from 2000 to 2014.
- This boom in commodity prices was largely due to the rising demand from emerging markets as well as the result of concerns over long-term supply availability.
How does US dollar influence the commodity prices?
- Historically there is an inverse relationship between the value of the dollar and commodity prices.
- When the value of the dollar drops, other countries will have more buying power, as it takes less of their currencies to purchase a dollar.
- This increased buying power naturally increases the demand and subsequently commodity prices increases and vice versa.
What happened after 2014?
- Deviation in relationship - The two years following the 2014 commodities supercycle witnessed a steep fall in prices.
- This coincided with the slowdown in the Chinese economy and resultant poor investment in the commodities space and poor demand globally.
- As a result, the association between the dollar and commodities prices reversed to a new direct relationship.
- Despite a strengthening dollar scenario, commodity prices increased due to -
- Election of Trump as the U.S. President leading to hopes of increased public investment in infrastructure projects.
- Signs of economic recovery and stimulus investment made in Chinese infrastructure making favourable impact on commodity prices.
- Global growth was getting stronger and as a consequence there was a boom in resources.
Why is the Supercycle expected now?
- The above mentioned market euphoria around a recovery in commodities demand due to a stronger global economy has died out.
- The U.S. dollar index has now dropped by almost 10% since the beginning of the year.
- But there is a rise in global commodities prices, reflecting the return of inverse relationship between dollar and commodity price.
Source: The Hindu, Business Standard
