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It could be argued that one of the better barometers for the health of the global economy is the commodity price cycle. Strong growth and robust demand conditions are associated with rising commodity prices, while recessions are inevitably linked to commodity price falls. The current recession is no different with the collapse in industrial production and with it, world GDP, driving a free-fall in commodity prices.

In the last two and a half months or so, commodity prices have unambiguously moved higher. From the lows of March 2009, the CRB index, for example, is up around 20% – a quite meaningful gain in a little over two months. This rise is clearly very encouraging and reflects the more positive tone in other markets – credit spreads have narrowed, stock prices have risen, volatility has fallen and just about everything considered ‘risky’, has rallied hard. It also fits with the run of generally ‘less bad’ economic news and even mildly positive news out of China where the policy stimuli packages have been quick to gain traction. Whether these economic developments mean a quick return to solid, even strong, economic growth, is the question that market and policy makers are starting to grapple with.

As the saying goes, a march of 1,000 miles begins with a single step and the 20% rise in commodity prices is certainly more than one step along the path to consolidation in the economy or maybe even a more general recovery. But having noted that, the absolute level of commodity prices remains at levels that are consistent with recession. Even allowing for recent gains, the CRB index is down around 50% from the record high recorded in July 2008. Perhaps even more sobering is that fact that the CRB index is still around 5% below the average of the last 20 years, a shocking trend at a time when the U.S. CPI (by way of
comparison) has risen around 80%. To be sure, there have been some productivity gains in mining and food production – great gains to be sure. But commodity prices are hardly pointing to a strong or sustained recovery. Not yet anyway. Further gains need to be registered before we can be absolutely sure that the recovery has substance. So like many other indicators, it remains to be seen whether the pick up in commodity prices is a relief rally or the start of something more exciting.

What is also somewhat worrying about the sustainability of the commodity price pick up of the last few months is that many producers have adjusted supply lower, they have closed mines and as a result they have what is likely to be a huge capacity to ‘turn the key’ to add to production should the global recovery prove to be durable. This element of commodity prices – the supply side – suggests that when compared with the 2004 to 2008 boom, this commodity price cycle will be muted. Any further increases in prices would likely see these mining projects coming back, adding to supply and possibly stymieing the price pick up just as it was getting underway.

It is a similar story with shipping freight rates. One of the higher profile measures, the Baltic Dry Freight Index has risen a tub-thumping 300% since the low in December 2008. In isolation, this looks to be a stunningly strong but this move is probably viewed like the recent trends in Citi’s stock price – the gains from the lows are very impressive, but the absolute level is still pathetically weak.

Even with the recent surge in the freight index, it is still more than 75% below the peak level recorded in May 2008. While the previous peaks are unlikely to be tested any time soon – if at all – it is still somewhat ambiguous whether the freight shipping rates are sufficiently robust to unambiguously signal a commodity price turn.

All of this means, the commodity currencies are quite away ahead of the cycle with some stunning rises in recent weeks in AUD, NZD, CAD and BRL. While each of these have much more than commodity prices to drive momentum, a turn lower in commodity prices would stem the increases in these currencies.