Is the rapid rise in metals prices due to depreciation of the dollar? Or is it due to global supply-and-demand factors?

To determine the extent to which the dollar depreciation is causing the metals price increases, we must analyze how tightly related metals prices are to movements in the exchange value of the dollar. First, it’s important to note which exchange value of the dollar matters. Against the “major” currencies, such as the euro, which tend to float freely in financial markets, the amplitude of the dollar cycle is substantially greater than that of the cycle associated with the “other important trading partners” (OITP) such as China, which tend to manage their currencies’ moves. From the peak in 2002, the dollar depreciation against the majors is about 30%, whereas the depreciation against the OITP currencies is only about 18%. To the extent that trade competitiveness depends on movements in exchange rates, trade competitiveness has changed the most vis-à-vis the European markets and suppliers from those markets to the global buyer.

But changes in exchange rates do not translate one-for-one into the prices of traded products. It depends on the extent to which producers and traders—whether domestic or foreign—pass through exchange rates into trade prices. That, in turn, depends on their strategy to gain or maintain market share, or their ability to increase profits or to absorb cost changes into margins. These strategies depend on a number of factors, including product heterogeneity and business relationships. Prices of and markets for metals exhibit several of these characteristics.

So what has been happening to prices of metals in international trade? Import prices of the commodity categories have shot up dramatically. Prices of the more fabricated pieces have risen, but only modestly overall—much less than any change in the value of the dollar. For example, from May 2004 to May 2008, the price index for iron and steel (commodity) increased 87.3%, to 292.6 from 156.2. The price index for articles of base metals (fabricated) increased by 19.8%, to 128.1 from 106.9. Moreover, the timing of the dramatic increases in import prices does not match the timing of the fall in the dollar from the 2002 peak (although the timing vis-à-vis the OITP depreciation appears more coincident).

Export prices follow a pattern similar to that of imports, with the commodity products experiencing sharper price increases and fabricated metals products experiencing less of a price increase. This pattern of dollar price increases implies that the prices of U.S. exports in foreign currency terms (which is the price that foreign buyers care about) have changed rather little for commodity products, but quite a bit more for fabricated products. Thus, the competitiveness of the price of U.S. fabricated products around the world appears to have increased substantially.

Dollar Sign

Looking at import and export prices together, it is clear that the dollar plays a role in the price increases experienced by metals products, but it cannot be the only factor. In particular, the timing is off, and moreover, prices for some products have moved substantially more than others. For companies that are both importers and exporters, importing commodity metals (whose prices have risen) and exporting fabricated metals (where prices have risen less) presents a challenging business environment. On the other hand, companies that are only exporters could be enjoying substantial profits if their domestic dollar costs are being held in line, since their export prices in dollar terms are rising.

A second important factor underpinning metals prices is global supply and demand. There is no doubt that the demand for commodities of all sorts by developing nations and emerging markets has impacted global commodity prices. Research by the International Monetary Fund (IMF) suggests that between 1985 and 1990, demand from emerging markets accounted for more than half of global demand for 10,000 metric tons of aluminum and copper. The Organisation for Economic Co-operation and Development (OECD) rich nations accounted for almost all the rest, with China only a small player. By 2006, emerging markets still consumed 10,000 metric tons and the OECD consumption actually contracted, while demand from China alone rose to about 11,000 metric tons.

When global gross domestic product (GDP) growth is robust, metals prices rise. Moreover, just as global growth stabilized at high rates around 2004, China’s growth continued to rise, thus supporting a further price increase for metals. Indeed, The Economist reported in 2004 that China accounted for half of world consumption of cement, 30% of its coal and 36% of its steel. Further, copper imports rose by 15%, and nickel imports more than doubled. So the timing of the start of the dramatic rise in international metals prices matches the global growth profile more than the dollar move.

In 2006 and 2007, however, global growth started to level off, as did China’s growth. Yet metals prices continued to rise. Most analysts suggest that China’s growth will slow a bit more after the Olympics. Its own capacity to produce metals shot up during the price boom period, and that is set to come online. So the extravagant run-up in metals prices of the last two years based on exceedingly strong demand and weak supply is likely to come to an end.

Trade Prognostication

The change in the pattern of trade toward a more diversified set of export markets comes from both the dollar depreciation and the changing pattern of global demand. The dollar depreciation makes U.S. products more competitively priced, which directly increases exports. This diversified market stance is likely to be maintained as long as the dollar does not significantly reverse toward appreciation and as long as U.S. exporters aggressively appropriate market share from other suppliers worldwide.

In contrast, import sourcing is increasingly concentrated, in part because of the established capacity in China and a stable exchange value of the yuan. Only a dramatic change in the Chinese exchange rate or other economic (transportation costs) or noneconomic (political) factors would likely significantly change the pattern of import sourcing.

Catherine L. Mann is a professor of international economics and finance at the International Business School at Brandeis University, as well as senior fellow at Peterson Institute for International Economics in Washington, D.C. This column is based on the presentation “The Changing Value of the Dollar and Your Business,” featured at the 2008 MSCI Financial Executives Conference held in June in Denver.