- Oil and metals prices are down significantly this year
- For oil this seems to be predominantly driven by supply factors
- The decline of metal prices probably reflects the softening of global growth
- There is a clear negative relationship betweenoil price changes and subsequent US real GDP growth
- US growth is expected to face a number of headwinds in 2019 but thedecline of the price of oil should act as a tailwind
From their highs earlier this year industrial metals are on average down about 20% and Brent oil about 30%. Looking at commodities as inputs in production processes, this type of decline provides ample reason for concern. This is the signalling role of commodity prices. However, they can also be considered as a driver of demand: big commodity price drops represent a favourable supply shock which should end up boosting final demand in the economy and hence economic growth.
This is the interpration that president Trump seems to be favouring. His pressure on Saudi Arabia and OPEC in general, not to cut production would, if successful, make the decline in oil prices permanent. Generally speaking this should support growth although oil producers would suffer from declining margins. Unsurprisingly the spread of the US high yield bond index, which has a high percentage (close to 16%) of energy producers, has widened significantly, mirroring the drop in oil prices. Does the tug of war between US shale oil producers and oil exporting countries fully explain the behaviour of the oil market in recent months or does it also signal weaker demand? Based on econometric techniques, the weekly Oil Price Dynamics report of the Federal Reserve of New York provides a decomposition of the change in oil prices in demand and supplyrelated factors.
This analysis suggests that the 27.3% drop in the price of Brent oil between 6 July and 30 November, reflects a softening of demand effect of 5.5%, a supply effect of 15.6% and an unexplained residual of 6.2%. This result provides some relief to those who would interpret recent oil price developments as an additional sign of weakening global growth, in conjunction with weaker survey data.
Caution is nevertheless warranted. In a recent blogpost, an economist at the Bank of England has demonstrated that “metals prices are timely, highly correlated with world economic activity and perform well at predicting short-term movements in GDP.” This is confirmed in table 1 which shows a statistically significant positive correlation between the quarterly change in metal prices (LMEX) and real GDP growth in the current and following quarter, so lower metal prices point to slower growth. For Brent oil however the relationship is negative and not statistically significant.
The role of commodity prices as a driver of subsequent growth was analysed on the basis of model-based simulations. Using the NiGEM model, a permanent decline in the price of oil of 25% has a positive impact on the level of US real GDP after two years of about 1%. In the eurozone the impact is about 0.7%. A drop in metal prices on the other hand has a negligible and short-lived impact. Metal prices may be useful when producing a real-time estimate of economic growth, but in the short to medium term, it is the price of oil that matters.
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