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Primary
commodity prices are well known to be highly volatile.
Indeed, they are not just subject to short boom and
bust cycles driven by demand and supply shocks, but
also longer term cycles and secular trends driven by
more structural and evolutionary forces.
There are many reasons for such volatility. First there
is the strong relationship between climatic change and
weather conditions. What is often less noted is the
fact that even demand conditions are affected by weather,
such as the demand for oil. Since the demand for most
primary commodities is anyway less price-elastic than
for manufactures, this means that any variability in
supply gets associated with far greater price variability
than in the case of manufactured goods.
In the case of perishable commodities, supply is inevitably
very inelastic in the short term. For certain other
primary commodities such as tree crops, the complete
production process takes considerable time so that shifts
in demand have a large impact on price in the intervening
period.
For perishable primary commodities in particular, the
costs of holding inventories tend to be high, which
further affects price response. Since holding inventories
of virtually all primary commodities, even the non-perishable
ones, tends to involve significant costs, they are in
turn significantly affected by the prevailing rate of
interest. Thus movements in the rate of interest, which
change the costs of holding these inventories, can be
associated with changes in product price as such stocks
are released to or withdrawn from the market by private
traders. This tendency, which was noticed a century
ago, is still an important element in the various forces
making for commodity price volatility.
Indeed, even producers' organisations which are often
intended to stabilise world market prices in particular
commodities can have the opposite effect if they contribute
to volatility through large shifts in supply. One example
of this is OPEC, which has certainly affected international
oil prices through its changing decisions on production
and supply.
However, even by the standards of the past, the volatility
of primary commodity prices appears to have increased
quite dramatically in the past two decades. As Chart
1 indicates, primary commodity prices have been more
volatile than the prices of manufactures in the last
two decades, and both oil prices and non-oil commodity
prices have fallen relative to the prices of manufactures.
The chart provides data from the World Bank for the
period from 1984 to late 1999. The unit value index
of manufactures in this chart relates to the manufactures
exported from the G–5 countries (France, Germany,
Japan, United Kingdom, and United States) weighted by
the country's exports to developing countries.
Chart
1 >> Click
to Enlarge
This evidence of higher volatility is confirmed
by other studies, all of which suggest that the volatility
of primary commodity prices increased sharply following
the collapse of the Bretton Woods system in the early
1970s and has remained high thereafter, going up further
in the 1990s. According to the World Bank publication
Global Economic Prospects for Developing Countries
2000, the standard deviation of the absolute value
of the year-on-year changes in the non-energy commodity
price index during 1970–98 was 11.5, compared with
5.7 for the manufactures unit value index during the
same period. |
