morganstanley.com
QUOTE
Global: Global Recession Promotes Commodity Deflation
Richard Berner (New York)
It's official. We now expect that global growth will slip below 2.5% this year, qualifying as a global recession (see Steve Roach's accompanying piece, "A World in Recession"). The U.S. slump has spread in varying degrees to virtually every region of the world, promoting weakness in both output and demand. This rapid deceleration is bad news for commodity prices, even for energy prices. While there is little doubt that the prices of most commodities are determined by the interplay of supply and demand, it is now the demand slowdown that is the driving force. Unless producers take steps to rein in supply, commodity prices will continue to slide. And in turn, that's not good news for the world's commodity exporters.
Commodity prices are already sliding, and slower global growth isn't exactly new, so one might reasonably ask, isn't a global recession already in the price of many commodities? The Journal of Commerce-ECRI industrial price index, for example, has tumbled 7.7% so far this year, standing at levels not seen since the global financial crisis in 1998. And Morgan Stanley's basic materials analysts report that weak demand is crushing pricing. Wayne Atwell this week reduced his forecasts for aluminum, copper and nickel, noting that "2001 appears to be shaping up as the weakest year since 1982, the last year of synchronous economic weakness." Matt Berler thinks that pulp prices, which have already plunged 21% from their recent peak, may be near a cycle trough, while linerboard prices are softening. Les Ravitz notes that all major chemicals prices fell in June, with buyers waiting for further price declines. And our gasoline traders note that weak demand has reduced crack spreads practically to zero and wholesale prices to 70-75 cents. They suggest that retail gasoline prices may fall another 20 cents, on top of the 25-cent decline since Memorial Day.
Alas, there may be still more bad news ahead. The reason: commodity prices are leveraged to global growth, so a slowdown produces hefty price declines. In turn, that leverage results from the insensitivity (economists call it inelasticity) of both supply and demand in the short run to price changes. With a "steep" supply curve, a slight weakening in demand will produce a significant decline in prices. The demand weakness exposes excess capacity that companies cannot or will not shut in quickly. Simple statistical relationships suggest that this leverage factor is roughly 5 to 1; i.e., a 1% drop in global GDP growth will produce a 5% decline in commodity prices. No wonder that the JOC index has declined by 11.1% on average in the past three global recessions. Because most commodities are priced in dollars, a stronger dollar tends to weaken prices further; it offsets the benefit of the price declines for non-dollar buyers.
Supply is obviously critical as well, and nowhere more than in the most important global commodity, crude oil. OPEC's adroit supply management has thus far kept quotes in a $25-$30/barrel range over the past year despite the global slowdown. Clearly the worsening global economic backdrop confronts oil ministers with a major test of their ability to curb output; while our traders suspect they will cut production if necessary, only time will tell.
While weak demand has crushed commodity prices, the commodity price declines will help modestly to set the stage for recovery. Lower prices will boost discretionary spending power for consumers and mute the drop in demand. For energy quotes, even if OPEC maintains its discipline, the declines in petroleum product prices and in wholesale electricity quotes will help businesses and consumers alike. Chances are that consumers will be the biggest beneficiaries, both in the U.S. and elsewhere. That's because weak demand and excess capacity are combining to limit retail pricing power. As a result, companies likely will pass the benefits of declining commodity prices on to consumers. For our U.S. recovery call, the coming decline in consumer inflation will be a critical supplement to the forces of monetary and fiscal stimulus that we believe will promote a revival in growth by the end of this year.
UNQUOTE |
