The year 2014 has already shown bearish signs in the financial markets as stock markets have dropped by more than 5% and many financial forecasts point to a turbulent market year. The prices of commodities, having already significantly declined in 2013 with the exception of energy, are under close scrutiny this year by analysts as indicators of overall strengths and weaknesses of the global economy. In a recent report, the World Bank has forecasted a gloomy outlook for the prices of commodities such as energy, metals, agriculture, and fertilizer.

To read the World Bank’s gloomy outlook for 2014 click here.

In brief, commodity prices are expected to decline in 2014 adding strength to the argument that the decade-long commodity boom has come to an end.

Since the beginning of the 2000s commodity prices have been in what is commonly known as an upward commodities supercycle. It was during this time that commodity trading outperformed US and Canadian stock markets (75% growth in comparison to the S&P 500’s 55% between 2000-2009), though not without some dips during the 2008 Financial Crisis. This boom was explained as the result of an increase in emerging market demand for natural resources, particularly from China as the country experienced a phase of better than expected industrialized growth. The unexpected increase in demand from China and other BRIC markets caught commodity traders by surprise and overwhelmed producers. With commodity supply and demand out of balance, it took raw material suppliers a decade to adequately supply the global surge in demand due to the costs and time requirements associated with the development of mines and relevant infrastructure. As well, the collapse of the US housing market in 2008 left many investors looking for safer investments which they found in commodities.

The reasons for the ending commodity boom are directly related to the reasons why the boom began in the first place. The most obvious is that China is no longer experiencing the double digit rates of economic growth that it was ten years ago and is facing weaker exports as the country is transforming into a more consumer based economy. Thus, demand for commodities has decreased due to the drop in economic growth from 11% to 7.5% which has allowed the supply of commodities to finally catch up to demand. The importance of Chinese demand on global commodity prices cannot be underestimated as best exemplified in the metals market in which China accounts for 45% of global metal consumption. Other emerging markets have a strong influence on commodity prices such as India and the precious metals market which is also declining as the Indian government has placed tougher restrictions on gold imports in an effort to balance their current account deficit. Robust economic data from the US has also affected the metals market, particularly in gold and copper. Concerns that the Federal Reserve will slow down its bond buying program amid signs of an improving economy have driven down metal prices which had been inflated by the US stimulus package. Fertilizer prices which soared during the boom are finally easing and expected to decline 11.7% this year as the industry is in a transformative stage that is bringing many companies back to the US to take advantage of the ‘energy dividend’ which will see US production increase.

As an economy largely dependent on the primary sector, the end of the commodity boom would have a significant effect on Canada. It is no coincidence that the income of the average Canadian family has been rising since the mid-1990s, beginning at about the same time as the commodity boom. High commodity prices certainly had a role to play with this and other trends such as the employment rate, which also grew during the past decade until the Financial Crisis at which point commodity oriented provinces like Alberta continued to experience rising employment. As the mining, oil, and gas industries in the Western provinces will suffer as a result of a bust, wages, incomes, and employment will certainly decline as well. Canadian producers of potash, a bulwark in Saskatchewan’s economy, have already experienced turmoil in prices as the oversupply of fertilizer has made prices decline. New potential sources of low-cost oil production in Iran and forecasts of the US becoming a net supplier of energy due to advances in fracking technology further put Canada’s high-cost oil production at risk. In essence, the end of the commodity boom will test just how firmly Canada relies on the resource sector for economic prosperity and on world supply/demand forces that are largely out of our control.

The value of the Canadian dollar is generally linked to commodity prices and so declining prices will almost certainly lead to a depreciating Canadian dollar. Despite the fact that the recent surge in oil prices was not met with a surge in the dollar, the price of oil is expected to fall soon to a more appropriate level. Although a depreciating Canadian dollar will have troubling implications for some Canadian consumers such as cross-border shoppers and businesses relying on imports, manufacturers will benefit. A declining Canadian dollar, if it declines enough, may lead to a resurgence in Canadian manufacturing particularly in Ontario and Quebec and help increase exports which have steadily been declining. Coupled with weak oil prices, which consumers can also benefit from, Canada’s hollowed out manufacturing sector may receive a much needed respite and recover its competitiveness. The expansion of non-commodity exports will be beneficial to the Canadian economy as it will bring much needed diversification and help to offset any negative effects from losses in the resource sector.

2014 will certainly be a significant year for financial markets as commodity markets rather than stock markets are forecasted for some difficult times. Whether or not the most recent commodities boom is at its end remains to be seen, but what cannot be denied is that the fundamental causes for the boom have in fact been reversed. Specifically, slowdowns in emerging markets particularly in BRIC countries such as China have dampened global demand for commodities. The implications for the Canadian economy are significant as the natural resource sector plays an integral role in the economy. It is time for policymakers and economists to address the changing macroeconomic situation and ensure that the Canadian economy transitions smoothly.

Feaured Photo from Fotopedia.

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