Commodity price slump not only reflects economic weakness

The recent sharp drop in commodity prices is not a reliable sign of broader economic weakness, some analysts claimed.

At 'face value', the drop in prices over the past year is comparable to that seen during the worst moments of the financial crisis in 2008-09. Does that tell us something that is not yet visible in other data?

"The latest commodity slump has mainly been driven by supply-side and financial factors, including a collapse in investor confidence, rather than by a major downturn in economic activity," Julian Jessop, chief global economist at Capital Economics wrote in a research report sent to clients on Thursday.

Nonetheless, "this warning sign cannot be dismissed lightly," the economist added, pointing out how most industrial commodity prices have fallen by between 25% and 50% in US dollar terms over the preceeding 12 months.

In the case of the oil price, Jessop emphasised how so-called supply-side factors, such as OPEC's decision to maintain its output levels and the shale revolution in America, and not just economic weakness (demand), had contributed to the slide in crude quotes on international markets.

Even so, one risk arising from the oil price rout is that lower prices depress investment in producing nations more quickly than consumer spending is boosted by higher real incomes.

Regarding the price of copper, also widely regarded as a bellwether for economic conditions, historical data showed it tends to fluctuate with the current state of manufacturing activity in the People's republic of China. However, it did not provide any insights about the future.

Indeed, there was nothing yet in the data to suggest a 'hard landing' was at hand, Jessop explained.

Then there is increasing "financialisation" of commodities. That means that the gyrations in investor sentiment and positioning were increasingly important factors determining their prices, rather than 'real' demand for those same materials.

Against that backdrop, the spate of 'flash' PMI surveys for August scheduled for release on 21 August were set to be particularly well timed, having remained well clear of 'recession territory' until now, despite the commodity price slump, the think-tank concluded.