Ofelia Marín- Lozano | The close to 40% drop in raw material prices over the last year has called many investment strategies into question. It has been taken as an unmistakable sign of a strong slowdown in China, auguring a very negative outlook for producing countries. It is true that the indicators for raw materials have accumulated a substantial decline in dollar terms in the last twelve months, but a detailed analysis reveals some important differences:
- The price of energy-related raw materials (lead by crude oil) have fallen about 50% in dollar terms, but that of other raw materials have only experienced a moderate drop (-18%). As a matter of fact, some raw material prices have risen, particularly food (tea, oil, chicken, also wood pulp..)
- In euro terms, and not in dollars, the decline is significantly less, and the price of non-energy raw materials has hardly dropped at all (-5%), as can be seen in the following graph.
Periods of dollar weakness have always coincided, historically, with periods of strong raw material prices and vice-versa. The trend in the price of the raw material par excellence, namely crude oil, both in euro and dollar terms, shows that there is greater price stability if measured in the eurozone currency terms.
This is also the case with the immense majority of the raw materials. From a supply point of view, an important part of raw material production costs (wages) are fixed in the local currency of the producing country. And from a demand point of view, it’s Europe or Asia, where the population’s purchasing power is in local currency and not in dollars, who are the big net consumers.
So a stronger dollar, if not accompanied by a fall in the price of raw materials, would have an expansionary effect on the producing countries’ margins, while depressing the purchasing power of consumer countries.
The fact is that the demand for raw materials continues to rise (although in some cases at a slightly slower pace). As on previous occasions, the decline in prices has been largely due to the dollar’s rise (with the exception of crude, where there has been a clear increase in supply.)
So it doesn’t look like the world is on the brink of a major slowdown, nor do the producer countries appear to be on the verge of collapse. According to recent IMF forecasts, global growth is seen at between 3% and 4% from now until 2020 (compared to 3.1% in 2015 and 3.4% in 2014). The developed economies will show a very slight improvement, with Brazil and Russia slowly recovering, while China will once again lead this global dynamism, with growth of over 6%.
Looking ahead, it seems logical to think that in the case of the majority of raw materials, any significant price recovery can only be expected in a context of a depreciating dollar. In the case of crude, a price recovery would have to come from an adjustment to supply, given that its rise has been the main reason for the price decline.
That will happen slowly as new investment projects in fracking or tar sands are abandoned. These are only profitable at full cost with crude prices at levels of over 60-70 dollars per barrel.
The market has seen that the alarm bells sounded about a halt in growth in China were clearly unfounded. Without getting into whether China’s growth will drop from the expected 7% to 6.9% (the figure from the last quarter) or to 6.5% (the minimum target established by the authorities for the next five years), the fact that the major global companies’ sales in China are still at high levels show us that any approximation to a catastrophic scenario is baseless.
For example, Apple is selling double what it sold in the same quarter of last year, Coca Cola and McDonalds’ sales are up over 10%, while in the case of Adidas and Mercedes Benz they are up 15% and 40% respectively. These are not the typical figures of an upcoming recession, but represent the fact that private consumption is very strong and has taken over from industrial production for export (more raw materials and energy-intensive) in terms of its contribution to economic growth.