Commodity crash

The sudden price crash in global commodities markets last week, after they had peaked at all-time highs at the start of the month, took most observers by surprise. The shock value was all the more because it was the steepest weekly drop in 50 years, exceeding by a substantial measure the previous record weekly slump of 9.2 per cent, way back in December 1980. That drop had been triggered chiefly by a 20 per cent hike in interest rates by US banks on instructions from the Federal Reserve, which wanted to tame rampant inflation. The present cave-in is also remarkable in that it has cut across the gold, crude oil, metals and agro-commodities markets, including corn, wheat and vegetable oils.

While there may have been no prior signals ahead of this dramatic week, the price collapse is not inexplicable, especially if the factors that had led to the building up of the commodities bubble are taken into the reckoning. The International Monetary Fund (IMF) had attributed the buoyancy in commodities prices, including crude oil, to speculative factors. The bearish stock markets and the weakness of the US dollar had prompted investors to look for new asset classes for parking their funds. Commodities, in particular gold, seemed a good bet. But once the fears arose about a possible economic slowdown in the US and several other major economies, it gave rise to speculation that the commodities price boom may not be sustained in the wake of a drop in demand. The consequential scramble among investors and speculators for profit-booking in commodities is, thus, partly responsible for last week's price slide. Besides, the downturn in crude oil prices, dropping back to below $100 a barrel, strengthened the slide in the prices of several agricultural commodities like wheat, corn and vegetable oils, which were viewed as alternative sources of crude oil (bio-fuel). The fall in the global prices of some of these commodities has exceeded 20 per cent. Moreover, with the dollar suddenly looking healthier following rate cuts by the US Federal Reserve and the equity markets showing some signs of having bottomed out, many investors chose to return to these markets. These developments seem also to have corroborated the point that the commodity and stock markets are alternative investment avenues.

However, while it is too early to guess how long the downturn in commodity prices will last, it probably cannot be taken to spell the end of the commodities boom, and may well end up being no more than an overdue market correction. If past experience is any indication, commodities tend to rebound after every price crash because of supply factors, though the bearish phases tend to last longer than the bullish ones. What is most important, from a macro-economic management point of view, is that the unprecedented heights scaled by commodity prices had fanned inflationary fires, posing severe challenges to governments "" especially those with poor populations. From that view-point, the drop in commodity prices will provide welcome relief to India, and also give some elbow room to the Reserve Bank, which must have been grappling with the trade-off between fighting inflation and choking growth. Still, it is important to bear in mind that last week's events may not mark the end of volatility in commodities markets.