A commodity cure for economic ills?

Commodity prices were again generally higher overnight, buoyed by a range of positive economic news in Europe and the US.

The German ZEW survey was a corker, with the index for the current economic situation at 18.3 points, up from 10.6, while expectations jumped to 42 points from 36.3 points. At the same time, eurozone industrial production rose a solid 0.7 per cent in June. In the US, retail sales were up 0.2 per cent in July following a 0.6 per cent rise in June, to confirm a solid uptrend in spending through the course of 2013.

This positive economic news added to what has been something of a stealth rally in many commodity prices. Over the past month or two, commodity prices have been moving higher, a point that is being reflected in the Australia dollar which has lifted from below 89 US cents a few weeks ago to around 91 US cents this morning. And this Aussie dollar gain is against a stronger US dollar, which means the trade weighted index is up around 2.5 per cent from the recent low.

This commodity price lift and greater global optimism is showing up in Australian resource stocks. BHP Billiton, for example, is up 19 per cent since early July, while Rio Tinto is up more than 21 per cent in that time.

Here’s why.

From the low point around two months ago, the iron ore price in US dollar terms has risen around 35 per cent to $US141.80 a tonne. This extraordinary price lift must reflect stronger demand, particularly from China. As Australia’s largest export, the higher iron ore price by itself is injecting some upside to the economic outlook.

The commodity price gains elsewhere are also noteworthy. The price of gold, having dipped below $US1200 an ounce in late June, has rebounded more than 10 per cent to around $1325. From a low of around $US88 a barrel in April, the price of West Texas Intermediate crude oil has jumped nearly 20 per cent to this morning’s level of $US105 a barrel.

The trend is similar for copper, nickel and other metals as the market is increasingly confident of a sustained global expansion and a sustained lift in demand for commodities over the medium term.

Even the most recent Reserve Bank index of commodity prices, which is weighted on the basis of the size and relevance of Australian exports, has risen in Australian dollar terms from what was a ‘mini-low’ in November 2012. The Reserve Bank index in July was a solid 9 per cent higher than in November, a clear reflection of an adjustment in commodity prices and the Australian dollar that will give a boost to the economy if the lift is sustained.

That said, the Reserve Bank and Treasury remain particularly downbeat about the global growth outlook, with sharp falls in the terms of trade projected over coming years. This seems odd given recent global news and the commodity price improvement. While they might be right, the better news on the global economy and key commodity prices presents an upside to their view. If it does materialise that the Reserve Bank and Treasury are a little bit ‘glass half empty’ with their current forecasts for commodity prices and the terms of trade, the implications will be clear.

The Reserve Bank will not only have finished its interest rate cutting cycle, but there would likely be a series of interest rate increases during 2014 and 2015. For Treasury and the budget, there would be a revenue windfall which would boost the budget bottom line, meaning a surplus in 2015-16 and beyond.

All up, there is growing evidence that the global economy is positioning for a synchronised upswing in 2014. If this is the case, we could see the next phase of the commodity price super cycle where prices remain elevated for longer.

To be sure, these trends can change, but for now the momentum higher on commodity prices is good news in general, but particularly for Australia which is increasingly well placed for a very strong 2014.