A post in March suggested that commodity markets would cool as emerging-world growth slowed in response to monetary tightening. Industrial commodity prices remain closely correlated with E7 industrial output – see first chart.
The timing of the correction, however, seems partly to reflect central bank liquidity operations. A post last week noted that G7 bank reserves were no longer rising, with the Fed temporarily sterilising its QE2 purchases (by requesting that the Treasury hold more cash in its Fed account) and the Bank of Japan allowing the post-earthquake liquidity boost to unwind. These trends are confirmed by the latest data – second chart.
Commodity bears may need to exercise caution near term since QE2 has yet to complete and the Fed could choose to “unsterilise” its recent purchases if weakness extends to equities and credit markets, resulting in a generalised tightening of financial conditions. For the moment, however, events are probably playing out to the Fed’s satisfaction. Inducing a correction in commodities, indeed, may have been an intention of Chairman Bernanke’s refusal to entertain QE3 speculation at last week’s press conference – consistent with the recent cessation of liquidity injections.
