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Rising Prices of Raw Materials

#Key Business Issue l 2021-03-01

Business Watch

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The COVID-19 pandemic hit the global economy hard last year, leading to a sharp decline in prices of raw materials including copper, iron ore and oil. But commodities prices are back on the rise. Prices of copper, which is sometimes called “Dr. Copper” for its economy-predicting properties, have risen to a ten-year high, while the mineral index has surpassed 2,000 points for the first time in ten years. This index is calculated by Korea Resources Corporation by measuring the prices of 15 minerals including copper and nickel. Oil prices have also returned to the level before the pandemic. The latest upswings in metal and oil prices may indicate an economic recovery. But the price surges are also attributed to massive liquidity in the market, fueling concerns of inflation as well.

Here is Kim Gwang-seok at the Institute for Korean Economy and Industry to discuss the recent pickup in commodities prices and its potential impact on the Korean economy. 

Copper is called “Dr. Copper” because of its ability to predict whether the economy will recover or decline. Copper prices fell to the lowest level of 4,600 dollars per metric ton in March 2020 but they skyrocketed in February this year. 

Prices of other industrial metals such as aluminum, palladium, nickel, zinc and cobalt have also surged. On a similar note, oil prices have climbed to their highest level in a year. Demand for oil tends to rise in line with an economic recovery. The price of the benchmark West Texas Intermediate crude, for example, fell to minus 37.6 dollars a barrel last year, but it has exceeded 60 dollars a barrel lately. 

Apart from the prices of industrial metals and oil, those of agricultural products and grains have also soared recently. Corn prices have reached their highest level in eight years since January 2013, while prices of soybean and sugar have hit a seven-year high and four-year high, respectively.

Some analysts view the rally in the prices of raw materials as a sign of an economic recovery, while others say ample liquidity, which central banks around the world have scrambled to pump, is adding to inflationary pressure.

The global economy has been recovering, though slowly, since it faced a severe shock in the second quarter of last year due to the pandemic. Many countries have pushed ahead with massive stimulus plans, as seen in the Korean-version New Deal drive and the U.S.’s large-scale investment in eco-friendly industries. In the process, demand for raw materials has been on the rise. Also, COVID-19 vaccines are feeding hopes for a clear economic recovery, contributing to rising prices of raw materials. 

It is widely believed that prices of commodities will continue an upward trend for the time being. Based on the projection, some expect the so-called super cycle, or a long-term boom, of raw materials. 

Goldman Sachs and JPMorgan have recently said that a long-term structural super cycle of commodities has begun, citing six factors including economic recovery, monetary expansion and fiscal stimulus plans. But it’s hard to predict a super cycle just because of economic recovery, which I think will not last as long as 10 to 20 years. Speaking of monetary expansion, further cuts of key interest rates are unlikely. Rather, governments are expected to wind down quantitative easing. So, monetary expansion will not last long, either. The same is true of the fiscal stimulus plans. I imagine the plans will be executed aggressively until 2022, but after that, the situation will be different. A weak dollar trend can be understood in this context. So, the upward trend in commodities prices will continue for some time, but I wouldn’t say it will lead to a super cycle. 

The upsurge of commodities prices will benefit the steel, shipbuilding, shipping and oil refining industries. The rising prices mean an increase in demand for raw materials, and those industries are expected to improve their business performance. 

In a broader sense, however, the trend may pose a burden on the Korean economy. Resource-poor South Korea depends heavily on the import of raw materials and grains. The drastic rise in prices of raw materials will increase companies’ production costs as well as the cost of living. Local exporters may lose their competitiveness, while low-income households will find it more difficult to make ends meet. That’s why analysts are concerned over inflation, even while welcoming the rising commodities prices as a sign of recovery. 

For Korea, rising prices of raw materials will increase import prices and production costs. Consumer prices will subsequently rise as well. The International Monetary Fund has estimated the average consumer prices growth of advanced economies this year at between 1 percent and 2 percent. 

It remained in the zero percent range in 2020. Advanced countries set an inflation target of 2 percent to keep inflation stable. Given that, the projection for this year is considered appropriate. In this sense, it would be fair to use the term, “reflation,” which refers to the first phase of economic recovery after a period of recession. I think consumer prices growth is returning to moderate levels. 

Inflation is considered good or positive when it is based on rising demand and recovery expectations. But it is considered bad when it is driven by dwindling supply and cost increases. Fortunately, many analysts now see the positive side of inflation, in which prices grow gradually on the back of an economic recovery. 

Governments around the world are expected to accept inflation to some extent in order to help their countries overcome economic shocks from the pandemic and achieve recovery quickly. Even so, it is necessary for Korea to fend off damaging effects of inflation stemming from rising prices of raw materials and excessive liquidity. 

Commodities prices will likely continue to rise. Therefore, Korea needs to make greater diplomatic efforts to secure raw materials without any problem. It would be done by strengthening its partnership with countries producing raw materials. The government may also help companies extend their contracts with those countries so they will not face any setback when procuring raw materials. While prices are expected to grow at a stable level, food prices may go up sharply to place a heavier burden on low-income families. I think the government will also have to draw up a policy aimed at stabilizing food supply and demand. 

Korea’s consumer prices only grew 0.4 percent in 2019, 0.5 percent last year and 0.6 percent in January this year. But prices of oil, food, houses, stocks and cryptocurrencies are all increasing. 

Given the upswings in global prices of raw materials, prices of industrial goods and public utility fees may also go up in the near future. Inflationary pressure is felt more vividly by vulnerable groups. The government needs to focus on its risk management efforts in preparation for the return of inflation. 

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