Monday, December 27, 2010

"How inflation creates commodity mini-cycles"

From Stefan Karlsson's blog at the Christian Science Monitor:

What is the effect of inflation on commodities prices? It's more subtle than you might think.
As Jim Rogers persuasively argued in his book Hot Commodities, most commodity prices goes through long super cycles because commodities have a low short term price elasticity of supply and demand., while having a lot higher long term price elasticity of supply and demand.

If there is a big increase in demand (or decrease in supply), supply (from new sources) can increase only slightly in the short term because it takes a lot of time both for natural reasons and political (environmentalist, bureaucratic etc.) reasons to find more of for example oil and metals, and even when new resources are found, new obstacles of both natural and political nature prevents them from being actually extracted.
As a result, the increase in demand from some or decrease in supply must in the short term be met by a decrease in demand (from others) through higher prices.

Moreover, the required short term price adjustment is further elevated because most people find it too difficult or expensive to adjust in the short term. If they have an SUV and gas prices go through the roof, they still might not switch to a hybrid car because the switch would be very expensive.

For these reasons, sudden increases in demand or decreases in supply will cause dramatic short term price increases and these increases will usually stay for a while.

However, after several years, new wells or mines will be found and after several more years, commodities will be extracted from them. As a result, supply will start to significantly increase. Moreover, after several years with elevated prices, people will have been able to reduce their use or perhaps even entirely substituted it. As a result, demand will significantly decrease....MORE
See also:

Société Générale's Dylan Grice-"Commodities: ‘Their Expected Long-Run Real Return is 0%’"