Academic journal article Contemporary Economic Policy

Relationships among Strategic Commodities and with Financial Variables: A New Look

Academic journal article Contemporary Economic Policy

Relationships among Strategic Commodities and with Financial Variables: A New Look

Article excerpt

I. INTRODUCTION

There is a common belief that commodity prices tend to rise and fall together. There is also a recent conviction that oil price is the most volatile and may lead to price procession. It is not surprising that commodity prices may move in unison because they are typically influenced by common macroeconomic factors such as interest rates, industrial production, exchange rates, and inflation. Moreover, some commodities are related in the sense that they are complements (e.g., oil and metals, silver and copper) or substitutes in consumption (e.g., gold and silver), and inputs in the production of others (e.g., oil, silver, and copper). On the other hand, related commodities such as gold and silver may not comove well over time as they have other economic uses. Studying the comovement and its explanations may be more relevant to strategic commodities such as oil, gold, silver, and copper, which are influenced not only by the ordinary forces of supply and demand but also by their own special factors. The strategic commodity prices also share one characteristic that other industrial commodities (e.g.. aluminum, platinum, zinc) do not; they have long, consistent daily data series that helps examine their comovements and interactions. These strategic commodities are also among the most traded on the world markets, and they influence and are influenced by macrofinancial variables. Rises in commodity prices usually fuel expectations of higher inflation, giving rise to monetary policy tightening and resulting in ensuing increases in interest rates. Increases in the prices of precious metals, gold in particular, could lead to a flight to the gold safety and away from the dollar, resulting in dollar depreciation. It would be interesting and useful to discern whether the four strategic commodities (oil, gold, silver, and copper), short term interest rates and the U.S. exchange rate move together over time, and also to understand the moving forces behind each one of them. It would also be worthwhile to see how the precious metals, gold and silver, move over time in presence of oil, short-term interest rate, exchange rate, and an industrial commodity such as copper and which commodity leads the price procession. In fact, copper is called the metal with a PhD in economics or Dr. Copper because it predicts changes in the business cycle (Lahart, 2006), and gold is sensitive to inflation. Are these assets substitutes for the same type of risk or are they different in the sense that they can be used in portfolios that diversify away risk? We are also keen on finding out how the U.S. dollar behaves relative to major currencies in the presence of prices of precious metals and copper, as well as the interest rate. Would the flight to the safety of gold hold when the dollar depreciates even when other pertinent variables are accounted for?

On examination of the literature, one can discern two major areas of research on commodities that are relevant to this study: price comovement and information transmission in the presence of economic fundamentals. Gold also has its own additional special areas including investment diversification and reserve asset. One of the early studies on price co-movements is Pindyek and Rotemberg (1990). This study finds excess comovements in prices of seven unrelated commodities. (1) Other research, however, finds less "excessive" comovement in prices of commodities (Deb, Trivedi, and Varangis, 1996; Palaskas, 1993; Palaskas and Varangis. 1991; Trivedi, 1995). Using the concordance measures, Cashin, McDormott, and Scott (1999) analyze the veracity of the comovements of prices of 17 related and unrelated commodities. In particular, they find no evidence of such comovement in the prices of the seven unrelated commodities studied by Pindyck and Rotemberg (1990). They do, however, find strong evidence of comovement in the prices of related commodities. On the other hand. Ciner (2001) finds that the stable long-run relationship between gold and silver on the Tokyo Commodity Exchange disappeared in the 1990s, and more recently, they have their own separate markets as they are considered to have different economic uses. …

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