Thinking about commodity prices: What do you think the risks are?

The June terms of trade numbers (due out on Wednesday) are likely to come in lower than they did in March – as a result of the huge lift in petrol prices over the quarter. However, even so, New Zealand’s terms of trade will still be at a historically elevated level.

A higher terms of trade implies that we need to sell less in order to buy the same basket of goods overseas – in other words, it indicates that our country is effectively wealthier. This is ultimately a good thing for the country.

The increase in the terms of trade has been the result of a lift in the price of commodities that New Zealand sells overseas – specifically dairy. More recently beef and lamb meat have joined the party, while other commodities such as coal and aluminum have also performed well. Although import prices have also increased (specifically the cost of inputs such as fertiliser and fuel), the lift in New Zealand commodity prices has been dramatic.

However, risks to commodity prices have appeared, with the dairy component of the September ANZ commodity price index recording a 7.5% slump in August!

Do we think that dairy prices can be sustained near current levels – or is the price going to fall sharply? Even if we don’t have a bubble in dairy prices, Economists View has a good piece on why commodity prices may have a long way to correct – specifically, the potential for a supply response.

This begs the question – is the increase in New Zealand’s income going to last. How much of it is a structural increase? What do you think – I will write on it following the TOT data.