Saturday, November 13, 2010

Commodity Price Changes as a Consequence of a Weak Dollar

I know a lot of folks are pointing to real demand as the driver of commodity prices since Chairman Bernanke's August 27 Jackson Hole speech.

Putting a little perspective on the question are some charts presented by James Hamilton at Econbrowser in his November 10 post "Commodity inflation".
First up, the buck vs. the euro:
The dollar strengthened against the euro with last spring's sovereign debt concerns, but has slid back dramatically since this summer. My view is that the anticipation of the Fed's latest quantitative easing measures has been a key factor in that slide.
Source: FRED.
Next, the expected dollar price of oil given the realized dollar weakness:
It's interesting to look at how big an increase in commodity prices we would have expected given the size of the dollar depreciation and given the size of the recent correlation. It turns out that the recent run-up in oil prices is no mystery, given the magnitude of the dollar depreciation.
Actual and predicted oil prices. Solid line: actual price of West Texas Intermediate (in dollars per barrel), Sep 1, 2010 to Nov 5, 2010. Dashed line: Sept 1 price times exp(1.3 times change in natural logarithm of exchange rate since Sep 1).
He shows the same correlation in an industrial commodity, see his post for the chart.
Ditto for copper prices. Note that the path for "predicted prices" in these two graphs is identical, since both are driven by the same realized exchange rate path....
...I feel that there is a pretty strong case for interpreting the recent surge in commodity prices as a monetary phenomenon. Now that we know there's a response when the Fed pushes the QE pedal, the question is how far to go.