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Commodity Price Movements in the Twenty first Century

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Commodity Super Cycles and Bubbles

Sharp movement in commodity prices, especially of oil, and some base metals like copper, since the turn of the century, have attracted enormous international attention and debate. The price of oil, which shot up from the sedate levels of approximately twenty-eight USD per barrel, a few years ago, to the high seventies, in 2006, sent ripples through the economies of advanced nations, even as it added billions to the current account surpluses of oil rich nations, like Kuwait. While the movement in oil attracted international attention because of its universal usage, prices of items like copper, steel, cement and uranium also soared to new heights.

These developments led to intense discussion among economic experts and business thinkers, who were divided in their opinion about the causes of commodity behaviour, as well as its future movement. While a large number of scholars feel that the recent movement in commodity prices is no more than the initial movement of a wave that will last for many more years, if not decades, others put it down to wrong economic policies and the work of market speculators. This research assignment aims to study and explore the various aspects of this extremely intriguing and globally significant development, and thus arrive at findings and conclusions that are able to illuminate the complex topic.

Executive Summary

This research assignment attempts to delve deeply into the causal factors behind the sharp upward movement in prices of commodities during the last six years. The assignment is structured into sections that describe the situation in totality, and then take up the many theories that have gained ground in recent years on the issue. While many people believe that a commodity super cycle is under way, powered by the demand for materials from an enormously fast growing China, others feel that these movements, like the one in the price of oil, is a twenty-first century reminder of the commodity bubble that took the price of tulips to astronomical heights in seventeenth century Holland.

The study includes an analysis of the commodity super cycle, the roles played by the growth of China and India in increasing commodity demand, the effect of liberal monetary policies, and that of speculative activity, in the price movement process. Detailed analyses of the thoughts and writings of experts on the subject, including thinkers like Jim Rogers and financial professionals like Stephen Roach, along with the study of texts and journals available on the subject, have led to findings that have lent themselves to some interesting analyses and conclusions. These will hopefully prove to be relevant in providing fresh perspectives, and increase available knowledge on the issue.

1. Introduction

a. Overview

Recent years have witnessed enormous changes in the global economic scenario. Much of what is happening in the cross continental market place owes its origin to the vision and determination of a slightly built and thrice married octogenarian, Deng Xiao Ping. Deng, the Chairman of the People’s Republic in the 1980s, introduced broad and sweeping changes in the Chinese economy under the name of the four modernisations. His reforms, which covered agriculture, industry, science and technology, and the military, opened up the Chinese economy, and were instrumental in transforming it into one of the largest and fastest growing economies of the world. (Deng Xiao Ping, 2007) Years of double-digit economic and infrastructural growth in China profoundly affected the economies of other countries, and, in the process, set off a huge tide of economic movement that encompassed the whole world. In the mid nineties, the socialist government of India, threatened by international debts, shrinking foreign exchange reserves, and an exasperated population, decided to catch up with its larger neighbour, and initiated a series of economic reforms that led to sharp increases in economic development, and catapulted the country into the ranks of the fastest growing world economies.

The unharnessing of these two countries, which together account for a third of global population, from the shackles of state economic control, has created an unprecedented demand for commodities. As China and India rush to make up for decades of low growth, poor living standards, and abysmal poverty, their booming economies are hungrily devouring ever-increasing quantities of metals, agricultural produce and oil products. This insatiable hunger, in the opinion of economists and market analysts, has led to the development of a sustained increase in prices of commodities, known in economic parlance as a commodity super cycle. Other thinkers and columnists have expressed dissenting views, blaming market speculators for building up prices to unrealistic levels and creating artificial bubbles; which were bound to burst, and cover all connected with a good amount of unpleasant and possibly disastrous debris.

b. Definition of problem

The current upward movement of commodity prices has assumed worrying overtones. The escalating prices of crude oil, which moved up, in a period of a few years, from the regions of the mid twenties per barrel, to that of the high seventies, perplexed and worried governments, and economic thinkers all over the world. Apart from oil, prices of many commodities, particularly metals and agricultural produce, have escalated to unprecedented levels, impacting price indices, affecting buying power, and unsettling economies on a cross continental basis. Price behaviours of different commodities are under detailed scrutiny, with experts trying to pin down their reasons. While the sharp increase in the price of maize is attributed to the diversion of corn for production of bioethanol for the US and Brazilian markets, (Trade aspects of Biofuels, 2007) the increase in prices of oil is thought to be due to its increased consumption in China and India. The huge boom in the Indian stock market, on the other hand, appears to be due to the large influx of foreign institutional investors, who have taken indices in the last two years to more than twice that of 2005.

While the enormous increase in economic activity has resulted in increased profitability for business corporations, and has presumably contributed towards reduction of poverty and want, the accompanying inflation has also brought with it enormous worries, particularly for governments of developing countries. Recent months have seen governments, (under tremendous pressure from angry citizens) and central banks raise prime lending rates, and use other economic tools to suck extra money out of the system, in futile attempts to contain runaway inflation. In the midst of numerous theories, the only constant appears to be in the movements of commodity prices, which continue to climb, of course with periodic pauses, and occasional corrections. The development of a long lasting commodity super cycle, in the opinion of many experts, appears to be the major causal factor behind the present circumstances. In this scenario, it becomes important for economic thinkers to focus on the actual reasons for this phenomenon, and its likely consequences, in order to take corrective action.

c. Objective

This assignment delves deeply into the issues related to commodity life cycles, and commodity bubbles, from economic, political and social perspectives, and with particular reference to the current global economic scenario. The subject matter is enormous and covers local and international developments in politics, society and economics. The assignment involves examination of primary and secondary information sources, and the study of available literature and research. It makes substantial use of secondary material in the form of texts, journals and magazine articles as well as internet sources for purposes of data availability, analysis and investigation. A good amount of thinking on the subject has occurred in the past few years with numerous experts expressing frequently contradictory and quite confusing views in their syndicated and one-off columns.

Despite serious and sincere effort, some important information regarding the topic may well have not found place in the assignment, a deficiency that could limit the validity of its conclusions. The bibliography provides complete details of the accessed information. The order of issues taken up for discussion is sequential, for the sake of logical progression of ideas and thought.

2. Literature Review

a. The Commodity Super Cycle

Economists have, for decades, believed in the theory of cyclical growth, characterised by periods of growth, followed by years of depression or slump. Events, economies, and political systems move through cycles similar to the natural life cycles of living beings. These cycles, while observable, have no obvious reason and involve changes between periods of comparatively swift increase of production, income and prosperity and periods of relative stagnation. (Business Cycle, 2007) These periodic movements do not follow an established or expected pattern and behave randomly, with extended, or short, growth or slump years. In the stock and commodity markets, these boom and bust periods have been famous for causing widespread prosperity or destruction. Cycles generally comprise of four distinct phases namely contraction, trough, expansion, and peak. Whereas expansions and contractions account for the major portion of the cycle, the troughs and peaks denote the lower and upper turning points where contractions change into expansions and vice versa. These cycles have been the focus of detailed economic study for ages with governments trying, mostly without success, to smoothen slumps, periods that have historically caused widespread unemployment, losses and suffering.

Business cycles are as applicable to commodities as to other elements of the economy and are generally measurable in movement of national or regional GDP. Occasionally, commodities move into a phase of upward movement in prices for extended periods, which continue for many years, sometimes even many decades. They mainly occur because of major economic developments that are significant enough to drive demand and consumption on a global basis for long periods. Super cycles form because of the industrialisation or urbanisation of a major economy, (Heap, 2005) a process that normally occurs over decades, and leads to situations wherein increases in supplies of commodities are unable to catch up with increases in their demand. These imbalances, while originating in particular geographical areas, occur for years and result in substantial price increases of commodities, and that too on a global basis, for extended periods.

What we can say is that there clearly are long-term cycles and that they are driven by fundamental changes in the world around us. Global wars, the industrial revolution, major innovations in transport and communications are just some of the factors that can instigate long-lasting shifts in economic growth, that in turn stimulate demand for commodities. Increased demand drives prices higher while producers struggle to increase the capacity to meet that demand. Ultimately, prices peak when excess capacity has been developed – the cycle is then completed when demand abates and general surpluses force prices lower. (Guthrie, 2007)

Two discernible super cycles have occurred during the last 150 years. (Heap, 2005) Huge economic and infrastructural growth in the USA, during the turn of the nineteenth century, created a super cycle in commodities. Later, commodity super cycles developed during the post war reconstruction of Europe followed by enormous economic activity in Japan.

If you look at history, there have always been super cycles in demand for commodities. There was a super- cycle during the British industrial revolution, during America’s huge period of growth before and after the second world war and during Japan’s industrialisation in the 1970s.” (Cooper, 2005)

Many economists feel that the movement of commodity prices since the turn of the millennium indicates that the global economy is in the midst of a strong commodity super cycle, a phase that has just about started and still has a long way to go. Gary Dorsch, writing for SafeHaven (2006) states that the Reuters Jefferies Commodity Price Index (CRB), which comprises of futures in “live cattle, cotton, soybeans, sugar, frozen concentrated orange juice, wheat, cocoa, corn, gold, aluminium, nickel, unleaded gasoline, crude oil, natural gas, heating oil, coffee, silver, copper and lean hogs” has reached levels 91 % higher than what it was four years ago, its highest level in 26 years. Apart from the behaviour of the CRB index, prices of oil have increased seven times from its 1999 levels.

Demand for oil is about 85m barrels a day at the moment and most people forecast that it will hit 125m barrels a day in the next 15 to 20 years. I see no way in which this will be met, so oil prices will stay high.” Goldman Sachs, the investment bank, has even forecast that the oil price could hit $100 a barrel in the event of a “supply shock” — a disruption to the supply of oil as a result of natural disaster, sabotage, war or political upheaval. (Cooper, 2005)

Copper has also behaved in virtually the same manner from the lows it saw in 2001. “Now it’s the turn of the grains, where wheat and particularly corn have exploded higher on the US futures exchanges.” (Guthrie, 2007) A number of other experts are reinforcing this phenomenon. While metals, led by base metals such as copper, aluminium and zinc, as well as precious metals like gold, silver and platinum have, until now, along with oil, led the price charge, prices of agricultural produce are also beginning to rocket. “Recently however, commodity traders have doubled sugar prices to 24-year highs, and are moving into coffee and soybeans.” (Dorsch, 2006) Prices of iron ore have risen to dizzying heights, practically 72 % in 2005.

While tracking of commodity prices is an ongoing activity, the frenetic movement of prices during the last seven years has added another dimension to the issue. Numerous articles, either prophesying its continuation for many more years or predicting a roll back in the near future, pack the pages of financial journals and magazines. Each minute movement in commodity prices is subjected to detailed scrutiny, compared with trends and used as a base for future forecasts. The majority however appears to be in consensus that the current trend of increasing prices, across a cross section of fuel, metal and agricultural commodities should remain in place for quite some time.

b. Main Causes behind Current and Expected Price Behaviour in Commodities

While numerous major and minor reasons affect commodity price behaviour, this discussion focuses on a few major reasons, widely accepted to be the primary causal factors behind the constant and significant price increases of the past few years.

The liberalisation process kick started by Deng Xiao Ping, in China, in the early eighties, led to developments that were possibly beyond his wildest expectations, and catapulted him into the ranks of those whose actions changed today’s world. The implementation of economic reforms accompanied with the opening of the Chinese economy resulted in unprecedented and unimaginable growth rates. During the last twenty-five years, the country’s economy changed from a centrally administered system, largely closed to international trade, to a market oriented economy with a rapidly growing private sector. Reforms, which commenced with the phasing out of collective farming, expanded to incorporate freedom from price control, fiscal decentralization, increased autonomy for state controlled enterprises, a large and diverse banking infrastructure, vibrant stock markets, the growth of privately owned and controlled enterprise and the opening of the economy to trade and investment. As China implemented the reforms in a phased manner, the restructuring and consequent efficiencies led to a year on year GDP growth well in excess of 10 % and a tenfold increase in GDP since 1978. The country, in recent years, has overtaken the most advanced nations of the world, and in terms of purchasing power parity, stands second only to the United States.

Exports are a key driver behind the Chinese economic miracle, with China's currency exchange controls and trade surplus with the US topping $204 billion in 2005, a 25% increase on the previous year and nearly 30% of the total US deficit. The lynchpin of Chinese exports is the low Yuan /dollar exchange rate pegged at 8.11 per dollar, undervalued by 30% to 40% on a trade-weighted basis. (Dorsch, 2006)

Growth has also driven enormous spending on infrastructure and urbanisation, with millions of Chinese relocating from villages to urban centres. Foreign investors, from the west, as well as from East Asian economies like Japan and South Korea have invested significantly in the PRC, making it, in many ways, the world’s factory. The country has the largest current account surplus, nearly 180 billion USD, in the world. (CIA Factbook, 2007)

This phenomenal economic and industrial growth, involving a ten-fold increase in GDP, has made the country a huge commodity consumer. “In China, intensity of use is now three times that of the USA, with demand driven by urbanisation, industrialisation and fixed capital formation.” (Heap, 2005) The Chinese miracle, with its huge demand for commodities has affected commodity prices profoundly in the past few years. “As China’s economy expands, it is sucking in raw materials to build up its infrastructure, including roads, power stations and factories.” (Cooper, 2005) This demand led to the country picking up a huge share of the overall growth in global consumption with growth in internal consumption. “The International Monetary Fund reports that its share of the overall growth in global consumption of industrial commodities between 2002 and 2005 was massive – 51% for copper, 48% for aluminium, 110% for lead, 87% for nickel, 54% for steel, 86% for tin, 113% for zinc, and 30% for crude oil.” (Guthrie, 2007) The country now accounts 12 % of global industrial production, compared to 6 % in 1995, 4 % of GDP on an exchange rate basis and 13 % on a purchasing power parity basis. Appendix A provides details about China’s demand for various metals.

The constantly increasing demand from China, despite regular predictions of slowdown, has served to propel commodity prices year after year. While these price surges have had their periods of relative stagnation, as well as corrections, the demand shows no sign of abating and should grow for many more years. The per capita consumption of beef, for example, in China is 12 pounds per person, compared to 100 pounds per person, in western countries. As perceptions change and the possibility of the country catching up in the prosperity scales with advanced nations becomes a reality, the projected increase in demand assumes overwhelming proportions.

While China has been and should continue to be a major driver of commodity prices for many more years to come, other factors have also contributed towards price movement and their effect may well increase in future. India, the world’s second largest country and its’ largest democracy started opening up its economy from the mid nineties. Shackled for years under a bureaucratic mixed economy regime that favoured the public sector, the country suffered from an abysmally slow growth rate for practically fifty years since it achieved independence in 1947. The opening up of the economy, and the introduction of economic reforms, while slower in implementation than China’s, (due primarily to the democratic and debate oriented nature of Indian society), nevertheless picked up steam by the end of the millennium, and entered an era of high growth in the early years of the present decade. The country is today, after China, the second fastest growing economy in the world, and is achieving growth rates of nearly 9 %. While both industry and services are growing at rates much faster than 10 %, agricultural growth has been comparatively slower.

India's Prime Minister Manmohan Singh, wants his country to achieve 10% economic growth in the next two to three years, to create more jobs and help lift a third of the country's 1.1 billion people out of poverty. Asia's fourth-biggest economy expanded 8% in the second and third quarters of 2005. Singh's government wants industrial production, which makes up a quarter of India's economy, to grow 10% annually to boost the incomes of Indians, one in three of whom live on less than $1 a day. India's industrial production grew at an annualized 8.3% rate between April and November 2005, faster than major economies like US, UK, the Euro zone, Japan, Brazil, Indonesia and Russia. Only China and Argentina recorded faster industrial production rates of 16.6%, and 9.6% respectively. (Dorsch, 2006)

In India, domestic demand makes up practically 70 % of the national GDP and dominates the economy, as opposed to exports, in many other nations. Indian imports, though lesser than that of China, doubled in the last three years, adding to commodity demand and strengthening the consumer super cycle.

Terming India's economic growth since 1991 "phenomenal," World Bank President Paul Wolfowitz on Saturday said its GDP (gross domestic product) growth could be pushed up by one to two per cent with speedy reforms. He said: "The dynamism shown by India in the last 15 years is phenomenal. India can do better... A couple of percentage more growth can be possible. But it needs sound fiscal and monetary policies. Continuity of reforms was important for the high growth, evident in the last 15 years. India's incredible growth story was a policy model to the world. It showed continued development in democracy and open society. (India’s growth story, 2005)

Apart from India, the two other BRIC countries, Brazil and Russia, are also growing strongly, strengthening the demand for major commodities. While the sharp spurt in growth shown by Japan in recent years has also fuelled demand, the growth generated by the BRIC countries, as well as economies of countries like Argentina and South Africa should continue for many years, even for some decades, as these countries try to achieve parity with the advanced nations.

Monetary policies followed by the central banks of most countries have also played a significant role in fuelling commodity price increases. Central banks of most countries, Japan, Europe, China and India have followed super easy money policies from the beginning of the millennium right upto the last quarter of 2006 and this along with the demand from the Chinese and Indian economies have worked towards pushing prices up to record levels.

The People's Bank of China increased its M2 money supply by 18.3% last year, issuing more Yuan to soak up foreign currency earned through foreign trade and direct investment into Chinese factories from abroad. Explosive money supply growth, in turn, boosted domestic retail sales by 13% last year, and industrial production was 16.6% higher in November from a year earlier. China's central bank raised its M2 money supply target to 17% in the third quarter from 15% earlier, to offset stronger demand for the Yuan, and maintain the peg at 8.11 per US dollar. (Guthrie, 2007)

In Japan, money markets have received trillions of yen, more than required by local Japanese banks, pushing interest rates on deposits to levels even below zero. This enormous amount of excess and free liquidity has enabled both Japanese and hedge fund traders to take up large speculative positions in global commodity markets. While conservative counsel advocates a stricter monetary policy, authorities are reluctant to make changes in a policy that has seen overnight lending rates staying at zero for nearly five years.

In Europe, loose money availability has also helped in fuelling inflation and price instability. The growth rate of M3 Money supply in Europe in Europe has become considerably higher than the previous year, and helped in lifting stock markets to higher levels. All over the world, bankers have seen commodity indices running away but refrained from taking action lest growth rates get hurt. Another factor that hinders bureaucrats from taking action after inflation starts hitting significantly high levels is the underlying fear of small course-corrective measures not working and the risk of dampening growth.” If a central bank stops excess liquidity too late it has to raise rates much more strongly and that causes turbulence on the markets.” (Guthrie, 2007) Indian policy makers, found to their chagrin, that inflation growth rates that had crossed 6.5 % (and were threatening to destabilize the government) proved immune to three doses of interest rate hikes, by 50 basis points each time.

A sharp hike in borrowing and lending rates took place in recent weeks. With inflation up at 6.4 per cent and the RBI saying it will take “all the necessary monetary measures”, further hikes in interest rates could come. But will raising interest rates bring inflation under control? Does India have the markets and institutional framework in which raising interest rates is an effective instrument for inflation control? Does India have a central bank that has learned how to conduct monetary policy in an open market economy? The answer to these questions is: No. In this sphere, India lags behind modern practices. (Patnaik, 2007)

While lack of faith in the measures taken by one’s own government appears to be a generic trait with analysts all over the world, sustained increases in commodity prices have led to a consensus that economic and monetary policies, followed all over the world, have been unbalanced in their blind preference towards growth, to the exclusion of inflation. The unbridled use of liberal monetary policies has contributed towards this present climate of inflation, and in strengthening the commodity super cycle. The creation of shortages because of rapid and unexpected growth in consumption is a fait accompli, and a short-term discomfort economists are ready to bear, (in the interest of growth), until increased supply stabilizes the situation. In the absence of measured intervention, unbridled increase in prices, apart from inducing speculative activity, also attracts hordes of genuine investors, big-ticket investment funds, pension funds, and even individual retail investors.

Pension funds, as well as small, retail investors are looking to commodities as a crucial part of diversification of any investment portfolio. Although schizophrenic commodity day traders could decide to turn massive paper profits into hard cash at a moment's notice, causing a 5% shakeout, the longer-term odds still favor a continuation of the "Commodity Super (Guthrie, 2007)

c. The Future of the Present Inflationary Movement

Commodity super cycles, by their nature and their reasons of origin, run for extended periods, for many years and some times for decades. Modern day literature refers to just two or three super cycle in the last two centuries, one caused by American industrial growth at the beginning of the twentieth century, and the other caused by post war reconstruction in Europe, followed by intense Japanese economic activity. The second super cycle lasted for nearly three decades from the late forties until the depression of the eighties. The current super cycle, if at all it is one, has gained momentum only during the last six years, and prima facie still has a long way to go. While monetary policies of powerful and rich individual nations, like the USA and Japan, as well as regional groupings, like Europe, will be able to influence commodity prices through tightening or loosening money supply, the extent of the commodity super cycle will depend primarily upon the growth stories being played out in China and India, and to some extent in the other two countries, Brazil and Russia.

While China and India are both on the fast track to economic prosperity, they remain countries with low per capita incomes and consumption. The desire to achieve economic prosperity, in these economies, will not be satisfied with achievement of national GDP targets but will continue until individual aspirations of people are met in these two countries.

We have China embracing capitalism. We have India embracing capitalism. That’s brought 2.2 billion people into play as very ambitious earners, who aspire to middle class status. If we take Asia, there are 3.5 billion people who aspire to the same middle class lifestyle many of us in the West take for granted. If we look further beyond Asia, this same phenomenon is evident with many other developing countries. We see it in parts of the Middle East with the Dubai city-state as an example. (Finch, 2006)

Two simple examples will serve to elaborate this argument. As stated earlier, per capita consumption of beef in China is 12 pounds per person whereas it is more than 100 pounds per person in the advanced countries. Similarly, in India, where the majority of the people do not eat beef, and around fifty percent are vegetarian, the per capita consumption of chicken is around 12 pounds compared to more than 200 pounds in the west. A recent report by Goldman Sachs states that even if, as predicted, both these countries reach the GDP levels of the USA by 2050, their per capita income will not exceed half that of the USA. This gives rise to two inferences, (a) the huge amount of latent demand in these countries and (b) the extended period over which these growth stories will possibly play out.

India's Prime Minister Manmohan Singh, wants his country to achieve 10% economic growth in the next two to three years, to create more jobs and help lift a third of the country's 1.1 billion people out of poverty. Singh's government wants industrial production, which makes up a quarter of India's economy, to grow 10% annually to boost the incomes of Indians, one in three of whom live on less than $1 a day. (Dorsch, 2006)

Apart from the enormous potential for prolonged economic and industrial growth that can occur because of progress in these two countries, the fact that India is moving roughly ten years behind China, could lead to a situation where India’s growth rates start improving further when China’s starts tapering off; thus extending the period of the cycle.

Climbing markets are prone to periods of lulls, stagnation and even correction. Experts feel that these phenomena are bound to continue to happen, but the demand for commodities will grow at such an overwhelming pace, not just in China and India, but also in other countries of the developing world that it will soon reassert itself and bring back bullish behaviour. While there is intense speculation in academic circles about the probable period of the inflationary run, very few people are ready to take a bet on its probable date of demise. Economists are quite sure of phases of economic activity where waves of activity and growth follow periods of slowdown and even stagnation. The problem arises when quantification is called for. In the past Dewey and Dakin in their book “Cycles: The Science of Prediction” (1947) that a super cycle that moves from trough to peak to trough can last for as long as fifty to sixty years. Obviously, these longer waves comprise of a number of smaller waves, where activity increases and decreases in finite periods

Even as convinced a believer in the commodity bull cycle as Jim Rogers points out that the shortest boom lasted 15 years, while the longest lasted 23 years. His conclusion is that we have much further to go, but don’t expect a great deal more precision than that. Oh, and don’t forget that we’ll endure some huge corrections along the way. (Guthrie, 2007)

Much of the current discussion on commodity super cycles owes its initiation to Jim Rogers; author of “Hot Commodities”, (2004) a firm believer in the continuation of the super cycle and the importance of China in moving the process forward.

Most people don’t understand the full depth of what’s happening there. It will be the next great country of the world and the Chinese are amongst the world’s best capitalists. The 19th century belonged to the British, the 20th century to America and the 21st century will be China’s. The Chinese aspire to have what the West has and the work ethic to get there. They save around 35% of their income whereas Americans save about 1%. Jim though is not a fan of India for reasons given in his latest book, Hot Commodities. He finds the prevailing view there "anti-capitalist" and protectionist, the infrastructure poor, the education system inadequate and the caste system degrading to women and inhibitive of economic progress. (Mackrill, 2006)

Rogers, who was the first to predict the commodities boom in 199 believes that oil should cross USD 100 per barrel and could well, go over 150. The absence of a major discovery for nearly 30 years and Chinese demand will be instrumental in pushing up prices to much higher levels.

Rogers, 64, who created a series of commodities indexes and foresees a long-term bull market in oil, metals and grains, said he hadn't changed his positive view. The Rogers International Commodity Index, which more than doubled in the past five years, has dropped 13 percent in six months on a total return basis. ``When you have big bull markets, 50 percent corrections, or retractions, are normal,'' he said in an interview yesterday. ``It has often happened throughout history in a bull market.'' Oil for February delivery fell 16 cents, or 0.3 percent, to $52.08 a barrel in New York today as of 11:06 a.m. London time. It earlier rose as much as 41 cents to $52.65. (Jim Rogers says oil will rise to $100 after correction, 2006)

Rogers bases his theories on continued price movements on historical facts and states that while the longest super cycle lasted for 23 years, this one is just 6 years old. The difficulties inherent in producing commodities quickly and in finding new sources of food ensure that imbalances between demand and supply continue to exist thus driving up inflation.

d. Commodity Bubble

Bubbles, in economic parlance, are very different from business or super cycles. However, a super cycle, as it constantly drives prices upwards provides numerous opportunities for prices to be manoeuvred artificially by independent market forces for personal gain and facilitates the creation of bubbles. In economics, bubbles are created when speculation in a particular commodity drives its price up to levels

In economic terms, a bubble occurs when speculation in a particular commodity drives the price of said commodity up to unsustainable levels. At a certain point of time when prices cannot go up any further, speculators start selling their holdings. In most bubbles, this sets off a panic reaction as people rush to liquidate their commodity holdings incurring heavy losses in the process. People who are unable to get out are left holding on to assets with significantly depreciated values.

In financial markets, a stock market bubble described to be a self- perpetuate rise or boom in the share prices of stocks of a particular industry. The term may be used with certainty only in retrospect when share prices have since crashed. A bubble occurs when speculators note the fast increase in value and decide to buy in anticipation of further rises, rather than because the shares are undervalued. Typically many companies thus become grossly overvalued. When the bubble "bursts", the share prices fall dramatically, and many companies go out of business. (Dot com bubble, 2007)

Bubbles occur with frightening regularity, an indicator of the abysmal memory and feeling of invincibility exhibited by speculators. It keeps on happening in the share market where waves of market confidence, for unconfirmed and sometimes unknown reasons, push PE ratios of “penny stocks” to ridiculous levels only to have them crashing down with the first indication of bad news. Housing rates are also subject to the bubble effect, and every country on the globe has witnessed periods of intense growth in real estate and housing prices, fuelled at times by unscrupulous developers, interest rate drops or liberal lending schemes, followed by sharp drops and periods of stagnation. One of the most famous and largest bubbles to blow and burst was the Tulip bubble that burst in Holland in 1637.

Carolus Clusius, a botanist, brought the tulip to the Netherlands in the last decade of the sixteenth century from Constantinople. The flowers, originally meant for a scientist’s garden, soon became popular in Holland and prices began to climb to extraordinary levels. Ordinary bulbs started selling for high prices and buying rare ones would involve parting with astronomical sums of money, roughly GBP 700 for one Viceroy tulip at current sterling valuations.

“At the height of the mania, in what seems a complete loss of sanity, the bulbs were deemed too valuable to risk planting by their (formerly) wealthy purchasers, and it became popular to display the plain ungrown bulbs. In at least one instance, the plan for safety backfired when a visiting sailor mistook a tulip bulb for an onion, and proceeded to eat it for breakfast.” (Wood, 2006)

The bubble reached its highest levels by 1637 with traders making and losing enormous sums of money in the trade, and local governments ineffective in moderating the exercise. Then one day, as per legend, a trader reneged on his tulip payments and within days, prices came crashing to a hundredth of their original price ruining thousands of traders.

It would have been very easy to laugh at the foolish Dutch if the tulip episode had not repeated itself hundreds of times since then. In the late 1990s, the western world experienced the rise of numerous internet companies that rode the back of public enthusiasm and gathered enormous amounts of money from the stock markets before even beginning production or marketing activities. Billions of dollars were spent by way of venture capitalists to internet start up companies to fund ideas that people, in hindsight, feel to be downright ridiculous.

The "dot-com bubble" was a speculative bubble covering roughly 1995–2001 during which stock markets in Western nations saw their value increase rapidly from growth in the new Internet sector and related fields. The period was marked by the founding (and in many cases, spectacular failure) of a group of new Internet-based companies commonly referred to as dot-coms. A combination of rapidly increasing stock prices, individual speculation in stocks, and widely available venture capital created an exuberant environment in which many of these businesses dismissed standard business models, focusing on increasing market share at the expense of the bottom line. The bursting of the dot-com bubble marked the beginning of a relatively mild yet rather lengthy early 2000s recession in Western nations.

Thinking is gaining ground that what is actually being described, and explained, as a super cycle, is actually a manifestation of a commodity bubble, similar in nature to the dot com bubble that lasted for several years, i.e., from 1996 to 2001, but ultimately crashed, and in the process hurt thousands of people. Sceptics are of the opinion that, strangely, commodities that have active futures markets are experiencing much larger price rises than those that do not. Aluminium, for example is spiking, while steel is not. (March, 2006) Similarly, while oil is experiencing sharp price rises, the same is not true of coal, leading to the inference that prices are being pushed up by speculative activity rather than strong demand. Robert Marcin, in an article in msn.com, (2006) goes on to state that while the demand from the BRIC economies is undoubtedly very strong, and expected to stay for a considerably long period, consumption figures possibly do not warrant the price rises that have occurred in recent times.

Everyone knows that explosive growth in energy demand from BRIC will support ever-higher oil prices. Well, we have the data, and the numbers say not so fast. Brazil doesn't consume much oil, not even registering in the top 10 consuming countries through 2004. The former Soviet Union consumed 3.7 million barrels per day last year, as it did in 2000. Not much growth there. Other Asia (India) consumed 8.7 million barrels, up less than wildly from 8.5 million in 2004. Not much growth there, either. China, the source of infinite demand growth for every commodity, consumed 6.6 million barrels per day in 2005. That was up from 6.4 million in 2004. Not very impressive. Few investors get it So, even with rapid growth in the BRIC economies, oil consumption slows dramatically. The pricing mechanism works, as it should in a capitalist system. Few investors really get how much demand growth slowed in the BRIC countries last year. The BRIC story makes for a great sound bite, but the numbers are quite different. (Marcin, 2006)

Well-known analyst Marc Faber has been warning for some time now, that prices of commodities, like real estate and stocks, are facing upward pressure because of speculative activity, in addition to increased demand. (Sjuggerrud, 04) Many experts have also begun to draw parallels between the behaviour of the commodities market to the dot.com boom of the late nineties

“Like clockwork, liquidity-driven investors have migrated from asset to asset, desperately in search of yield,” he (Morgan Stanley Chief Economist Stephen Roach) said. “The world is now in the midst of another bubble — this one in commodities.” The economist said the jumps in prices of materials the past few months are reminiscent of charts of dot-com stocks in late 1999 and 2000. “That speaks to an important aspect of any speculative bubble — price excesses that spread into the far reaches of an asset class.” (Spence, 06)

Three major reasons form the basis for Stephen Roach to classify the current commodity price movement to be more akin to a bubble than to a super cycle. First, while it is universally accepted that China’s huge commodity demand has been crucial in upsetting the global demand-supply balance and setting off a price climb, the Chinese authorities are now busy changing the direction of the economy from one totally dependent upon industrialisation and exports to one in which domestic consumption will also start playing a key role. The Indian economy, which relies upon domestic consumption for 70 % of its GDP, appears to be much more able to stand global shocks than other export dependent nations and the Chinese are rooting for a stronger domestic consumption base. This could entail the tightening of monetary policy and reducing growth to 7.5 %, a development that could lead to a sharp decline in commodity demand. Efficient use of energy resources, an area of intense activity in China today, could also lead to reducing demand for fossil fuels.

Secondly, US spending, backed by housing profits, is bound to drop and cause cutbacks in Chinese exports. This, in addition to the expected monetary policy could bring Chinese demand for commodities down very significantly. Finally, it is again widely acknowledged that enormous speculative funds have entered the commodities market. While speculators may be earning enough profits at the moment any significant slowdown could reduce returns, trigger off a widespread withdrawal and lead to a sharp reduction in prices.

3. Research Methodology

a. Overview

Business research, an integral part of social research, while similar to political research, also has its own unique factors that need consideration during the determination of research methodology and procedure. Research methodology primarily consists of distinct processes that include definition of the problem, framing of research questions, study of available literature and feasibility of obtaining primary and secondary information, determination of research procedure, recording of data, arriving at findings, analysis of findings and writing of conclusions. This assignment involves the study of commodity super cycles and commodity bubbles, their similarities, differences, causal factors and relationship, with particular reference to the current runaway escalation of commodity prices. The problem has been defined in detail in the introductory section, and as such, is not being repeated here. This section will thus focus on elaborating the research questions, analysing the various types of research procedures and methodologies available, choosing the most appropriate one for this exercise, and then proceeding from there to collect data, arrive at findings, analysing the issues brought forward to finally come to appropriate conclusions. The research procedure follows general research guidelines outlined in various literatures available on carrying out social and business research, all of which are detailed in the bibliography. Special mention needs to be made of Research Methods for Business Students, (2003) authored by Saunders, Lewis, and Thornhill, as well as Principles and Methods of Social Research, (2002) authored by Crano, and Brewer

b. Research Questions

An analysis of the objectives of the assignment, read with the definition of the problem, leads to the following research questions.

  • What are the salient features of a commodity super cycle and a commodity bubble?
  • How are the two phenomena different, and yet related to each other?
  • How does the current movement of commodity prices lend itself to interpretation vis-a-vis application of the two theories?

c. Availability and Choice of Research Methodology

The choice of the basic methodology for primary research will depend upon the nature of the assignment and the suitability of different available methods. Primary research strategies, in this case will involve a choice between (a) Quantitative Methodology, (b) Qualitative Methodology and (c) Study of Available Literature, for obtaining and analysing data. All three methods use specialised techniques and require detailed planning, preparation, knowledge of methods of data collection, ability to analyse collected data, both statistically and interpretatively, validate results and arrive at appropriate conclusions. Researchers often choose to adopt one of the three methods; sometimes they use a mix of all three, concurrently or sequentially. “Mixing methods has been the subject of considerable debate in the social sciences and has variously been regarded as anathema, as the outcome of everyday pragmatic research decisions, or as appropriate in some situations but needing to be carefully justified.” (Darlington & Scott, 2002, p. 119)

The various research methodologies need examination in detail and assessment in light of the information available, for a decision on the more appropriate methodology for the subject assignment. This is also because methods of data collection and choice of analytical strategies support the execution of research and, in the first instance, depend upon the objectives and reasons for the research.

A scientific approach necessitates the use of specific disciplines like scientific coherence and adequate evidence. The behavioural approach became associated with political research through work undertaken at the University of Chicago in the 1930s and involved the use of surveys to study political choices. Researchers look for identifiable patterns and norms in feelings, thoughts and behaviour in order to explain theories and hypotheses. Quantitative research is an inquiry into an identified problem, and based on testing theories. The goal of quantitative methods is to determine whether the predictive generalizations of a theory holds true. It refers to the use of measurement in the analysis of behaviours and attitudes. Statistical analysis is the most convenient way of arriving at a logical conclusion in situations that involve the behavioural analysis of large numbers of people. Quantitative analysis is initially somewhat bewildering to people unfamiliar with statistical models. However, the models used are reasonably simple and decision making is restricted to choosing the level of data to be used, the choice of the sampling technique, the sample size and the appropriate tool for measuring variability. Quantitative analysis involves two other major tasks that influence the quality of the final analysis, namely data collection and the final validation of results. Data collection can happen directly through the use of questionnaires and surveys, from opinion polls or from pre-existing material, like results of other research efforts or official statistics. (Harrison, 2001)

The use of quantitative methods in marketing and operational research is widespread and practically indispensable when information about large samples is required in tight time spans. Many researchers feel that quantitative research forms the core of social and business research because measurements are scientific, rigorous, and representative and the underlying principle of quantitative research assumes that results are an accurate representation of the population under study.

Concentrating only on quantitative strategies does however subject the research assignment to certain limitations. Standardisation of questionnaires and interviewing techniques tend to limit the research to testing of predetermined hypotheses. The design of questionnaires intends respondents to react to specific question lists created by the researcher, thus eliminating potentially interesting, spontaneous or tangential responses. Perhaps the greatest limitation of quantitative research lies in the fact that individuals with limited experience can perceive the results from poorly conducted studies to be irrefutable truth. Charts, graphs, and tables have empirical implications, and it is only natural to accept them as fact. However, information occasionally represented as truth can be completely unreliable. Any number of factors can affect the legitimacy of quantitative research. Questionnaires can contain leading questions, data collection methods can introduce bias and small sample sizes may render findings insignificant. It is also possible that an analyst will present only those findings that support an unseen agenda.

In the subject assignment, the research, which encompasses an investigation into the issues involved in the phenomena of commodity price movement, with special reference to super cycles, commodity bubbles, and the present economic environment does not involve very large groups of people. Furthermore, the research questions specified do not need quantitative responses. Rather than focussing upon objective measurement, the research questions deal with issues like “how”, “why”, and “what”, when pertaining to the issues confronting economies because of development of cycles or bubbles. In such a situation the use of quantitative methods is clearly not suitable and thus needs to be eliminated.

Qualitative research techniques thus need understanding and their applicability gauged for the assignment.

Qualitative research has an important role to play in understanding this world and in complementing other forms of knowledge. Qualitative research methods have descended from several disciplines and belong to twenty or more diverse traditions (Miller (Darlington & Scott, 2002, p. 2)

Qualitative techniques involve the understanding of human behaviour in depth as well as the reasons that govern such behaviour i.e, the how and why behind attitudes and consequent decision-making. Samples are therefore small and focussed and techniques incorporate skilled and extensive interviewing of respondents, observation, and examination of documents.

Qualitative research analyses political behaviour and attitudes, which it is not possible or desirable to quantify. Put another way, qualitative research 'tends to focus on exploring, in as much detail as possible, smaller numbers of instances or examples which are seen as being interesting or illuminating, and aims to achieve "depth" rather than "breadth"' (Blaxter et al., 1996, p. 60). It is generally accepted, therefore, that qualitative research allows for greater expression and insight. (Harrison, 2001)

The major difference between qualitative and quantitative research techniques lies in much greater involvement and the elimination of detachment on the part of qualitative methods. Qualitative research produces in depth and comprehensive information. The researcher uses subjective data, and observes respondents and participants, to describe the variables, as well as the interaction between the variables, in order to obtain a greater understanding of the matter under study. However, this very subjectivity in approach leads to difficulties in establishing reliability as in depth recording requirements necessitates the need of small samples. The quality of research depends largely upon the sincerity, objectivity, and freedom from bias, of the researcher or interviewer. It is not difficult to doctor reactions to meet hidden agendas, and qualitative results thus need stringent validation. (Bryman, 1992)

It becomes quite evident from an examination of qualitative research techniques that their application is bound to be much more time expensive than those used in quantitative research, and thus suit small sample populations that need detailed investigation. Qualitative research is also ideal for use in situations that need in depth information from individuals on a variety of issues that combine to provide a total picture. Straightforward responses to questions similar to those asked during surveys will lead to misleading information and invalid data. A perusal of the information available leads to concluding that many of the issues involved are multi dimensional, interpretative and could change with time.

A prima facie examination thus indicates that research methodology should focus on (a) use of qualitative methods, (b) a detailed study of available primary and secondary material, or (c) a mix of both.

The subject assignment covers a topic that is global in its scope and has arisen because of historical events spanning centuries. While primary research has proved to be of immense help, its scope, in this context, would have to be enormous, cover both qualitative and quantitative techniques and span vast geographical distances if it was to be truly representative and provide valid findings. The undertaking of an assignment of such huge proportions is outside the ambit of this exercise and replacing it with a small primary research attempt will not serve a valid research purpose. However, an extensive and detailed study of the primary and secondary literature available does throw up a number of relevant findings and helps in furthering an understanding of the problem and the current situation. This assignment has thus depended upon a detailed literature review, of both primary and secondary sources, including accessing official policies and websites of public sector organisations.

Apart from public and college libraries, the internet is a vast repository of information, and if accessed properly can provide invaluable and comprehensive information. Searching for information over the internet involves the use of search and metasearch engines as well as accessing a number of databases and online libraries, which enable the internet researcher to access vast numbers of books, journals and magazines. Compared to the data available on the internet, material available in print is extremely limited and its location and search involves a number of actions that are superfluous to accessing information on the net. Millions of books and other study material are now available on the net, some of which are out of print and most would be very difficult to locate in average bookshops.

While accessing material from the internet, adequate care has been taken to ensure that material accessed is from authoritative sources and that books are from well-known data bases like Questia and Harvard Business Review.

4. Finding and Analysis

a. Findings

Data for this research, as explained in the section on research methodology and procedure, has been obtained from an extensive study of literature available on the subject comprising of books, journal and magazine articles from physical and online sources.

Business cycles are phenomena that keep on happening with regularity. While there is no clear reasoning behind their causal factors, their inevitability has led economists to compare them with natural cycles and state that business cycles, comprising of periods of heightened activity followed by years of stagnation and even contraction are as inevitable as the movement of the globe. The periods of contraction and expansion are separated by plateaus, known in economic parlance as peaks and troughs, which comprise of periods of change when the development of economic conditions forces a directional change in business activity. While periods of expansion are marked by development, economic growth and increase in prosperity, depressions are characterised by industrial slowdown, la


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