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Today, what I wanted to do is explore what is happening in the commodities cycle, where we think commodities have been going and why they’ve done what they’ve done and where we think they’re going over the year ahead.
The commodities boom we have now is the biggest commodities boom since the 1950s, in fact. It’s now larger than the commodities boom in the 1970s.
But those booms of the 1970s and 1950s are once in a generation events and they happen only very infrequently.
Back in the 1970s, the then head of research of the International Monetary Fund, Robert Heller, was seeking to investigate why the commodity boom of that period was happening.
And what he discovered was that major commodity booms when they occur are associated with expansion of total international reserves. Now, total international reserves are the total of all of the foreign exchange and all of the gold held by all of the countries who are members of the International Monetary Fund.
And when this number rises very rapidly, then countries are able to finance higher and higher prices of commodities.
For example, if we think of this as similar to a Monopoly game, if the bank in a game of Monopoly provided the players twice as much money, what we would find was that in about three turns the prices of hotels on Park Road would be twice as much.
And so, when countries have higher and higher levels of international reserves, then that allows them to bid up commodity prices.
Around about two and half years ago, the US Federal Reserve started putting up interest rates. And as it started putting up interest rates that, for a short period, reduced the growth of international reserves.
And this led to a pause in commodity prices and this was a pause in commodity prices that we’ve had in the year past in 2006.
Now the result of that pause in commodity prices is that Australian export prices, as measured by the Reserve Bank of Australia, were increasing at 30% per annum at the beginning of the year, but as we came to the end of the year were only increasing at around about 17%.
That is to say the growth rate slowed and for some months the level of commodity prices went sideways.
And that whole process of a slowing commodity boom was going to continue to happen as long as the Federal Reserve kept putting up interest rates.
But now we’ve come to a period where the Federal Reserve has stopped putting up interest rates and looks like, by the end of this year, they’ll start cutting interest rates.
Given that the Federal Reserve has stopped putting up interest rates, the major thing that was holding back a resumption of the commodities boom is now behind us.
Of course all these things work with a lag. What this means is we think that by the end of this year, that is to say the end of 2007, we’ll be able to see a reacceleration in the growth of total international reserves.
This will allow countries to bid up commodity prices at a faster and faster rate, so that by the time we get to the end of the 2007, the pause in the commodities boom will be over and commodity prices will be reaccelerating.
Rather than the commodity boom having come to an end in 2006, it was merely taking a rest, a rest before a further up-move of commodity prices and a continuation of the commodities boom in 2007.
This is Michael Knox.
The commodities boom we have now is the biggest commodities boom since the 1950s, in fact. It’s now larger than the commodities boom in the 1970s.
But those booms of the 1970s and 1950s are once in a generation events and they happen only very infrequently.
Back in the 1970s, the then head of research of the International Monetary Fund, Robert Heller, was seeking to investigate why the commodity boom of that period was happening.
And what he discovered was that major commodity booms when they occur are associated with expansion of total international reserves. Now, total international reserves are the total of all of the foreign exchange and all of the gold held by all of the countries who are members of the International Monetary Fund.
And when this number rises very rapidly, then countries are able to finance higher and higher prices of commodities.
For example, if we think of this as similar to a Monopoly game, if the bank in a game of Monopoly provided the players twice as much money, what we would find was that in about three turns the prices of hotels on Park Road would be twice as much.
And so, when countries have higher and higher levels of international reserves, then that allows them to bid up commodity prices.
Around about two and half years ago, the US Federal Reserve started putting up interest rates. And as it started putting up interest rates that, for a short period, reduced the growth of international reserves.
And this led to a pause in commodity prices and this was a pause in commodity prices that we’ve had in the year past in 2006.
Now the result of that pause in commodity prices is that Australian export prices, as measured by the Reserve Bank of Australia, were increasing at 30% per annum at the beginning of the year, but as we came to the end of the year were only increasing at around about 17%.
That is to say the growth rate slowed and for some months the level of commodity prices went sideways.
And that whole process of a slowing commodity boom was going to continue to happen as long as the Federal Reserve kept putting up interest rates.
But now we’ve come to a period where the Federal Reserve has stopped putting up interest rates and looks like, by the end of this year, they’ll start cutting interest rates.
Given that the Federal Reserve has stopped putting up interest rates, the major thing that was holding back a resumption of the commodities boom is now behind us.
Of course all these things work with a lag. What this means is we think that by the end of this year, that is to say the end of 2007, we’ll be able to see a reacceleration in the growth of total international reserves.
This will allow countries to bid up commodity prices at a faster and faster rate, so that by the time we get to the end of the 2007, the pause in the commodities boom will be over and commodity prices will be reaccelerating.
Rather than the commodity boom having come to an end in 2006, it was merely taking a rest, a rest before a further up-move of commodity prices and a continuation of the commodities boom in 2007.
This is Michael Knox.
