Saul Eslake on commodity prices

Saul Eslake, Director of Productivity Growth Program at the Grattan Institute, yesterday presented a paper at the International Conference of Commercial Bank Economists in Amsterdam, the Netherlands, on some of the longer term demand and supply factors shaping the behaviour of commodity prices, over the past decade and over the next 5-15 years.

The full paper is below and as always from Saul the research is excellent and a recommended read.

The principal arguments of the paper are:

  • first, that the steady rise in commodity prices since the early 2000s is largely the result of strongly rising commodity demand, especially from the world’s two most populous nations, which are now passing through a stage of economic development in which, if history is any guide, the ‘commodity intensity’ of economic growth increases significantly;
  • second, that this stage of development probably has at least another decade to run in China and at least another two decades in India;
  • third, that a range of constraints on commodity supply, including changes in the cost structure and composition of the mining industry, the depletion of the more easily obtainable supplies of minerals and energy, declining productivity in agriculture, and (possibly) the impact of climate change, have meant that supply has been much slower to respond to this increase in demand than in previous cycles; and
  • fourth, that while the increasing ‘financialization’ of commodities markets over the past decade has almost certainly had the effect of amplifying the impact of these developments on prices, it has not caused them to run in a different direction than they would likely have done otherwise.

The paper contains some interesting conclusions and data about commodities futures.

To the extent that ecological factors may at some point inhibit the capacity of the Earth’s resources to support the convergence of living standards and consumption patterns in China and India to those of more advanced economies (something which this paper has not considered), commodity prices are likely to be higher, rather than lower.

[The charts below] depicts the most recent medium-term commodity price forecasts of the Australian Bureau of Agricultural and Resources Economics and Sciences (ABARES).

These forecasts reflect the view that, for many mineral commodities, and for some (but not all) energy commodities, supply will eventually respond to the sustained increase in demand driven by the urbanization and industrialization of China, India and other ‘emerging and developing’ economies, thereby capping the rise in commodity prices over the past eight years or so and in some cases resulting in a decline from current levels, but to levels which in most cases remain high by historical standards.

For some agricultural commodities, in the absence of further adverse weather-related events the upward trend in prices over recent years is likely to be substantially reversed, but in other cases more lasting supply constraints will likely keep prices at elevated levels by historical standards. From a global macro-economic perspective, the upward trend in commodity prices over the past decade, and the elevated level (by historical standards) at which many commodity prices seem likely to remain for some years to come, is perhaps most usefully seen as a major shift in relative prices – that is, of commodities relative to those of manufactured goods and commercial services (the prices of which have, and will continue to, come under sustained downward pressure as a result of the increasing and expanding production capabilities in these areas of the same economies who are putting upward pressure on commodity prices).

This shift in commodity prices relative to prices of manufactured goods and services amounts to a substantial improvement in the terms of trade of major commodity exporting nations such as Australia, Brazil, Chile, Peru, South Africa, and Indonesia, and hence potentially represents a substantial positive income shock. In Australia’s case, at least, this is the largest sustained improvement in its terms of trade in at least 140 years.

Australia’s terms of trade gains look like being larger than those of other large commodity exporting nations, because of its unique endowment of three of the commodities that are integral to the industrialization and urbanization of China and India (ie, iron ore, coal and LNG)

For these countries, Australia more than most, a key challenge for economic policy makers lies in how to ‘manage’ the consequences of what amounts to a substantial positive economic shock, and to ensure that the benefits of what for these countries is a ‘once-in-human-history opportunity’ are not squandered (as they have been in previous commodities booms). Establishing some kind of sovereign wealth fund, as many other commodity-exporting nations have done, and has been advocated by, among others, the Governor of the Reserve Bank of Australia (Stevens 2010) and the OECD (2010: 78), would be a useful step in that regard.

For most advanced economies, however, this shift in relative prices (commodity prices up, prices of manufactured goods and services down) represents an adverse movement in the terms of trade and hence, all else being equal, a detraction from national income, at a time when economic growth prospects are likely to be dampened by the need for sustained fiscal consolidation and by the losses sustained by households and financial institutions during and after the global financial crisis. The adverse terms of trade movement has been particularly acute for Japan.

China, India and other ‘emerging and developing economy’ commodity importers are also experiencing adverse terms of trade movements, although for them these are more than offset by ongoing rapid growth in real GDP. Nonetheless, their concerns over resource, energy and food ‘security’ could nonetheless lead them into policy choices which have adverse effects on their own consumers, as well as on commodity exporters, and potentially – if nations are unable to learn the lessons of history – into situations that could escalate into military conflicts.

We must all hope that political leaders show sufficient wisdom and restraint to avoid repeating those historical experiences.


  1. ABARE has lots of reports available so anyone can go and examine their price forecasts over a particular period. Upon doing so you will see that those forecasts are quite poor in so far as I doubt ABARE would outperform a random commenter on this website.

      • Their reports are good reading and have lots of interesting stuff but they should stop embarrassing themselves with price forecasts.

  2. ABARES figures may be mirage-like, but what the hell, they’ll have to do.

    As I’ve said before I tend to see future demand from China, India (Korea, Japan?, Asian Region generally) generally in-line with Saul Eslake although I am not quite so convinced of continued historical highs in pricing – attractive perhaps, not historical.

    Good News – FutureBoom On!

    Expensive maybe, demographic changing certainly and still more than half to be built:

    Into the future major projects may come from unexpected coalitions that re-energise economics previously stymied by geographic location:

    And if the America Rebuild meme get’s going – I’ll say it again – Gangbusters.

  3. …the increasing ‘financialization’ of commodities markets over the past decade has almost certainly had the effect of amplifying the impact of these developments on prices…

    Amplified is an interesting word. America had amplified house prices.

    Since the GFC the base metals market has been increasingly amplified. Prices rise directly with stockpiles rather than inversely. When you examine production, usage and price before and after the GFC you see that the amplification is not a result of strong demand relative to supply inso far as there is plenty of base metals available for sale.

    Having said that there has been artificial supply constraints. Aluminium represents the classic example of this. There is no shortage of aluminium anywhere along the production chain. There is a glut of aluminium in warehouses around the world with stockpiles at decade high levels. Base metals warehouses are increasingly being owned by the likes of JP Morgan, Goldman Sachs and other usual suspects. And what we find are reports that it takes 6 months to get aluminium out of a warehouse (owned by said usual suspects). This naturally creates an artificial supply constraint and we see high prices.

    So manipulation has also contributed to the amplification of prices.

    For a good read on the financialization check this out:

    • Yes, and another pertinent word from wave physics is “resonance”, risk on, risk off!

      Not a welcome phenomon for poorly engineered and controlled systems!

    • +1

      I thought it’s a pretty good report, and he’s covered a lot of points.

      I would have liked to see a paragraph or two on some policy towards a balanced economy otherwise good stuff.

  4. I note that ABARE’s forecasts for iron ore and coking coal look pretty grim — Peaking in 2011 and all downhill to 2016.

    Not that it matters, because one thing you can count on with ABARE’s price forecasts: They’ll be wrong!

  5. If my arse was shiny metal, Saul Eslake could bite it.

    Did he pay his carbon dioxide, atmosphere pollution tax when he jetted over to the Netherlands, to blow some hot CO2?

    • Deus Forex Machina

      Come on JMD…show some class, where’s your normal impenetrable argument

    • Saul,

      You’re important and successful. JMD, like most of us, is just a Joe Average. Unfortunately some like JMD will be jealous and manifest their jealousy through abuse.

      Ignore him.

      • Davey, thanks for your support. Actually, I’ve never believed I am “important”; and, in my former life at a large commercial bank, was often reminded of how unimportant i was within the hierarchy of that organization, lest i ever develop any illusions to the contrary. Anyway I notice ‘JMD’ hasn’t had the cojones either to indicate what he meant, or to identify himself so that readers may judge what motives he might have for what he says. His silence speaks louder than his words.

  6. Saul, when are you going to start investing with your own dough?

    isnt an economist like gordon gecko??

    • I am tempted to say, “Ponzimania”, when you start putting your own name to your remarks.

      Why is an economist like Gordon Gecko – a fictional character (albeit partly based on a real one, Ivan Boesky) in a 24 year old movie who was motivated solely by personal gain, unconcerned by the legality or morality of his actions or by the impact they may have had on others, and who ultimately went to jail? Is that your view of all economists?

      Pity we can’t tell what you do for a living, since you lack the intestitudinal fortitude to identify yourself.

      As it happens, I do “invest with my own dough”. Exept that I do it through an intermediary, partly because I don’t have the time nor the skills and discipline to do it myself (and I have learned the hard way that those are important requirements), and partly so that there can never be any valid accusations that my investment decisions are in any way influenced by things I might have learned as a result of my employment (a particularly important consideration in my previous employment).

  7. Great paper Saul. What worries me about China is your assumption: “Demand from China, in particular, for a wide range of commodities is likely to remain buoyant formany years to come, even if slowing labour force growth and the need to contain inflationarypressures results in China’s overall growth rate slowing from an average of 10.8% pa over the pasteight years to somewhere around 7-8% pa over the next five-ten years”. Now this is a reasonable assumption, widely shared and I’m not saying it won’t happen, I simply don’t know. But seeing as you mention “known unknowns”, it seems fair to canvass Rumsfeld’s additional factor of “unknown unknowns”, the potential for political crises etc. It seems to me that the China story also assumes that the CCP can continue to manage effectively an economy with high levels of debt and speculation. As you might guess I’m less bullish than you, but China does seem to keep on keeping on …