Never reason from a price change – the case of commodity prices

The big story in the financial markets this week is the continued decline in commodity prices – particularly the drop in gold prices is getting a lot of attention.

The drop in commodity prices have led some people to speculate that this is an indication that the global economy is slowing. That may or may not be the case. However, as Scott Sumner like to remind us – we should never reason from a price change. 

We have to remember that the price of commodities can drop for two reasons – either demand for commodities declined (that would be an indication that the global economy is slowing) or because of a positive supply shock (that on the other hand would be good news for the global economy).

The good news graph…

Supply demand supply shock And the bad news graph…

Supply demand demand shock

This is not the place to speculate about whether we are in the “bad news” or the “good news”, but global markets are nonetheless telling us that this is not the time to panic – global stock prices have been trending upward, while commodity prices have been declining.

MSCI CRB

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David Glasner also comments on the gold price – he has more interesting things to say than I have.

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9 Comments

  1. cthorm

     /  April 15, 2013

    I think this is clearly a decline in demand, not supply, but I don’t see this as a bad thing at all. In my opinion, for a little over a year we’ve been seeing an ‘expectations restructuring’ in the demand function for gold & precious metals. I like to think of this as rational investors confronting their beliefs in line with Bayes’ theorem (which would’ve been unnecessary if they understood MV=PY). This unwinding has been largely gradual until this week.

    Reply
  2. TravisV

     /  April 16, 2013

    Dear Market Monetarists,

    Could someone please post a chart comparing gold prices to the Nikkei over the past eight months? This represents a huge defeat for those who claim that inflationary policies are enormously dangerous!

    Reply
  3. bena gyerek

     /  April 16, 2013

    Demand in China. Good for the rest of the world.

    Reply
  4. Paul Andrews

     /  April 16, 2013

    Never reason from a price change? That’s exactly what you yourself do in the last paragraph.

    Reply
    • Paul, I think you are missing the point. One should never reason from ONE price change. Looking at more than one price will give you a more correct picture of the world. Hence, if commodity prices drop, BUT equity prices increase then that is an indication that we are not dealing with a global negative aggregate demand shock.

      Reply
  5. Benjamin Cole

     /  April 17, 2013

    For gold and oil, the role of speculation may also be important, in addition to supply and demand.

    The price of oil is inelastic in the short-run. Ergo, if the price is driven up on the NYMEX, in the real world, demand holds steady. This can last for a couple of years—-then you start to get elongated defines in price, like now.

    The price of gold is an incalculable metric set deep in the fevered cortex of the last buyer’s brain. Fear, greed, genuflection to divine Au—who knows?

    All gold is fool’s gold.

    Reply
  6. Ravi

     /  April 17, 2013

    And of course market monetarists will be acutely aware that changes in current demand and supply can be reflections of EXPECTED future changes in demand and supply – which may or not be correct. And that’s why we have markets!

    Reply
  1. Travis, Gold and Nikkei | The Market Monetarist

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