Commodity price volatility and policy

challenges: an emerging market

perspective
Juan José Echavarría
Governor

CVII Meeting of Central Bank Governors of CEMLA

29 April, 2019
 29/04/2019
Contents
Global financial conditions and commodity prices

Policy implications of commodity price volatility

Monetary policy implications of commodity price

volatility

2
 • Different theories have tried to explain commodity price behavior. For the case

29/04/2019
of oil…
‒ Super Cycles of Commodity Prices (Erten and Ocampo, 2013):
 There is a gradual change in prices long-term trends rather than a stochastic trend.
 During the period 1865-2010, four past super cycles are identified, ranging between 30
to 40 years and with large amplitudes varying between 20% and 40% higher or lower
than the long run trend.

‒ Random Walk and Regime Shifts (Hamilton, 2008)

 Oil prices have been historically unpredictable an follow a random walk. However, they
might be explained by different regimes at different points in time.
o Strong oil demand growth (e.g. China, Middle East and other newly industrialized
economies)
o Limits to expanding oil production (e.g. Drop in Saudi Arabia production since
2005)
o Cartelization of commodity markets
3
Sources: Erten, Bilge. Ocampo, José Antonio. Super Cycles of Commodity Prices Since the Mid-Nineteenth Century (April 2014). Elsevier, Vol. 44. Available at ScienceDirect: https://doi.org/10.1016/j.worlddev.2012.11.013
Hamilton, James D. Understanding Crude Oil Prices (November 2008). NBER Working Paper No. 14492. Available at NBER: https://www.nber.org/papers/w14492
 • After a period of high market tightness and volatility, international financial
conditions have improved and the expectations of further tightening have
decreased...
VIX Index 5-Year CDS
90 350

80
300
Peru Colombia
70
250
Mexico Chile
60

200
50

40 150

30
100

20

50
10

0 0
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19

Source: Bloomberg. Updated: April 24, 2019.

 29/04/2019
• …such changes in financial conditions might have effects on commodity price
behavior. Historically, high real interest rates have lead low real commodity
prices (Frankel 2006)*.

Goldman Sachs Commodity Price Index vs. FED Real Interest Rate
Annual, 1970-2017
1,2
The sector with the strongest correlation is cattle.
1
Other sectors with a strong correlation are copper,
corn, hogs and soybeans.
Log Real Commodity Price Index

0,8

0,6

0,4
y = -0,0342x + 0,7653

0,2

0
-2 0 2 4 6 8 10
FED Real Interest Rate (%)

5
Source: World Bank, Bloomberg
*Frankel, Jeffrey A., Commodity Prices, Monetary Policy, and Currency Regimes (May 2006). NBER Working Paper No. C0011. Available at SSRN: https://ssrn.com/abstract=913304
 29/04/2019
6
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• …The negative correlation between an increase in real interest rates and a
decrease in real prices of commodities occurs through a variety of
mechanisms (Frankel, 2006):

‒ By increasing the incentive for extraction/selling today rather than tomorrow, in

order to earn interest on the proceeds from the sale

‒ By decreasing firms’ desire to carry inventories (higher opportunity costs)

‒ By encouraging speculators to shift out of commodity contracts (especially spot

contract), and into treasury bills.

• In its empirical study, Frankel finds that when the FED real interest rate goes
up by 1 percentage point, it lowers the real commodity price index by 6
percent…
7
 29/04/2019
• Nevertheless, many other factors beyond real interest rates influence
commodity prices (e.g. weather, political conditions in producing countries,
sector specific microeconomic factors, etc.).

• Identifying the relationship between financial conditions and commodity

prices is extremely difficult and is a debatable issue that has been widely
discussed by academics.

8
• External financial conditions remain volatile…

29/04/2019
Market-Implied Probabilities for the FED's December/2019 Meeting
100%

90%

80%
77%
70%
62%
60%

50%

40%

30%
39%
38%
20%

10%

0%
May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19

Probability of Hike Probability of No Change (2.25-2.5) Probability of Cut

Source: Bloomberg. Updated: April 25, 2019

o Central bank monetary policy responses in developed economies are still uncertain and volatile
o Global trade, investment and output remain under threat from ongoing trade tensions
o Some downside risks in systemic economies such as the euro area, China and the United States persist
9
o Political uncertainty and geopolitical conflict in some countries also add downside risk to global
investment
 29/04/2019
• Hence, if there is a relationship between financial conditions and commodity
prices, external volatility could generate terms of trade shocks.

• Therefore, it is important to analyze the challenges that commodity price volatility

poses for policymakers in commodity dependent countries.

10
 29/04/2019
Contents
Global financial conditions and commodity prices

Policy implications of commodity price volatility

Monetary policy implications of commodity price

volatility

11
• In a vast number of countries, commodities are a key part of the national
economy...
Commodity exports (% Total exports) 2018

Source: IMF. UNCOMTRADE

1 Commodities groups: Food and live animals; Beverages and tobacco; Crude materials, inedible, except fuels; Mineral fuels, lubricants and related materials; Animal and vegetable oils, fats and waxes; Manufactured goods classified

chiefly by material.
12
2 The latest available data for Venezuela are as of 2013 and for Saudi Arabia are as of 2016.
 40
60
80

20

0
100
120
140
160
Mar-10
Jun-10
Sep-10

Fuente: Bloomberg
Dec-10
countries…

Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12

Chile
Dec-12
Mar-13
Jun-13
Sep-13

Colombia
Dec-13
Mar-14
Jun-14
Peru

Sep-14
Dec-14
Mar-15
Jun-15
Mexico
Terms of Trade (2010=100)

Sep-15
Dec-15
Mar-16
Jun-16
Sep-16
Argentina

Dec-16
Mar-17
Jun-17
Sep-17
Dec-17
Mar-18
Jun-18
Sep-18
Dec-18
Mar-19
• …Commodity price behavior affects terms of trade in commodity exporting

13
• …Commodity prices are highly volatile; in particular non-renewable
commodities (e.g. oil, energy and metal prices)…

Real commodity price index (1992=2010)

450,00

400,00

350,00

300,00

250,00

200,00

150,00

100,00

50,00

0,00
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Energy Agriculture Metals & Minerals

Source: World Bank

Deflected by MUV Index - A proxy for the price of developing country imports of manufactures in U.S. dollar terms, used to assess cost escalation for imported goods. Updated twice a year, the index is a trade-weighted average of
export prices of manufactured goods for 15 major developed and emerging countries, with local-currency based prices converted into current U.S. dollars using market exchange rates. 14
 • …In the last decades, oil prices have experienced a phase of high volatility,
which implies significant challenges to oil exporting countries…

USD / Barrel Real crude oil prices 1879 – 2017 (2017=100)

140,00

120,00

100,00

80,00

60,00

40,00

20,00

0,00
1879
1882
1885
1888
1891
1894
1897
1900
1903
1906
1909
1912
1915
1918
1921
1924
1927
1930
1933
1936
1939
1942
1945
1948
1951
1954
1957
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017
Source: BP Statistical Review of World Energy June 2018 15
1861-1944 US Average; 1945-1983 Arabian Light posted at Ras Tanura; 1984-2017 Brent
 • ..Shocks to commodity prices may be large, difficult to predict and with
variable persistence over time...

Oil in the 1990's, 2000's and 2010's

160 160
150 150
140 140
130 130
120 120
110 110
100 100
90 90
80 80
70 70
60 60
50 50
40 40
30 30
20 20
10 10
0 0

The solid line represents actual WTI crude oil daily prices for the period. The dashed lines are based on market projections for prices of WTI Futures Contracts from 1 month to the last data available of 2023 for some selected
transaction dates when WTI prices reached a peak or a trough (the futures curve generally starts two months after this).
16
 • …Oil price shocks imply highly volatile government revenues. Oil dependent
countries are more sensitive to oil price volatility than oil importers...

General government revenues growth and Oil Prices

USD / Barrel

30,00% 140,00
25,00%
120,00
20,00%
15,00% 100,00

10,00%
80,00
5,00%
60,00
0,00%
-5,00% 40,00
-10,00%
20,00
-15,00%
-20,00% 0,00

Oil Exporters Oil Importers Oil price (right axis)

Source: IMF
Oil exporters: Bolivia, Canada, Colombia, Ecuador, Iraq, Mexico, Nigeria, Oman, Peru, Sudan, United Arab Emirates, Norway, Kuwait, Qatar, Australia, Saudi Arabia. Oil Importers: Austria, Belgium, Germany, Spain, France, United Kingdom,
Japan, United States, Switzerland, Argentina, Brazil, Hungary, India, Poland, Turkey, Thailand, 17
 • …Because of difficulties in fully hedging against commodity price
fluctuations, commodity dependent countries take precautionary measures,
such as establishing sovereign wealth funds. Currently these funds hold more
than USD 4.1 trillion...
Sovereign Wealth Funds 2019 Sovereign Wealth Funds 2019
(% GDP) (% Principal energy and mineral exports)
Brunei Norway
Kuwait Brunei
Norway Saudi Arabia
United Arab Emirates United Arab Emirates
Qatar Kuwait
Libia Qatar
Saudi Arabia Libia
Azerbaijan Azerbaijan
Kazakhstan Kazakhstan
Oman Oman
Australia Australia
Argelia Russia
Russia Colombia
Peru Mexico
Colombia Canada
Canada Peru
Mexico Nigeria
Iraq Iraq
Nigeria Argelia
0,00% 100,00% 200,00% 300,00% 400,00% 500,00% 0% 1000% 2000% 3000% 4000% 5000%
18
Source: Sovereign Wealth Fund Institute. IMF.
 • …The existence of a sovereign wealth fund to cope with energy and mineral
price volatility has important macroeconomic implications. Energy and
mineral exporters with large sovereign wealth funds tend to have, on
average, higher gross national saving rates...
Gross national saving (%GDP)
70 Energy and mieral exporters Energy and mineral exporters
(with large SWF) (without large SWF)
60

50

40

30

20

10

0
Australia Kuwait Norway Oman Qatar Saudi United Bolivia Canada Colombia Ecuador Mexico Peru Sudan
Arabia Arab
Emirates

2013 2015 Av. 2013 Av. 2014

Source: IMF. SWF: Sovereign Wealth Fund. Gross national saving (gross operating balance (revenue – expense, excluding consumption of fixed capital) excluding net capital transfers receivable)
19
 • …Accordingly, energy and mineral exporters with large sovereign wealth funds
tend to have precautionary fiscal policies…
General government fiscal balance (%GDP)
40
Energy and mineral exporters Energy and mineral exporters
(with large SWF) (without large SWF)

30

20

10

-10

-20
Australia Kuwait Norway Oman Qatar Saudi United Bolivia Canada Colombia Ecuador Mexico Peru Sudan
Arabia Arab
Emirates

2013 2015 20
Source: IMF. SWF: Sovereign Wealth Fund. Fiscal deficit: General government net lending/borrowing (revenue – expense – net gross investment in non financial assets)
 • …A downswing in energy and mineral prices causes exporters of these
commodities to be perceived as riskier. However, exporters without sufficient
hedging mechanisms are more sensitive.
Change in 5-year CDS (pbs 2014-2015)
Peru
Energy and

large SWF)
exporters
(without
mineral

Mexico

Colombia

Australia
mineral exporters
(with large SWF)
Energy and

Norway

Qatar

Saudi Arabia*

Hungary
mineral importers

Thailand
Energy and

Turkey

Poland

Brazil

(20,00) - 20,00 40,00 60,00 80,00 100,00

Source: Bloomberg. SWF: Sovereign Wealth Fund.

21
*7-year CDS
 29/04/2019
Contents
Global financial conditions and commodity prices

Policy implications of commodity price volatility

Monetary policy implications of commodity price

volatility

22
• As a first policy implication, depending on country circumstances, a flexible
exchange rate might help to cope with commodity price volatility. In Colombia,
the floating exchange rate regime has worked well as a shock absorber. However
certain preconditions should be fulfilled…
Exchange Rate (left axis) vs Terms of Trade (right axis)
COP/USD 2000=100
3.500 250,00

3.000
200,00

2.500

150,00
2.000

1.500
100,00

1.000

50,00
500

0 0,00
Jan-00 Jan-04 Jan-08 Jan-12 Jan-16 23
Source: Banco de la República
 1. Limited currency mismatches. Currency mismatches remain low and contained
in both the real and financial sector.

Debt of the Corporate Private Sector by currency and FX Net Open Position of the Financial Sector
22% (Assets minus liabilities in foreign currency) 2.800
45% hedge

% of Technical Capital

USD Million
Upper regulatory limit
(% of GDP) 1,5%
19%
3,1%
40%
2,4% 2.100
16%
35% 4,7%

30% 13%

1.400
25% 10%

20%
7%
32,4% 700
15% FX Net Open Position (% Technical
4% Capital)
10%
1%
FX Net Open Position (RHS)
5% 0

0% -2%

2010 2011 2012 2013 2014 2015 2016 2017

-5% -700
Non-exporters Debt (unhedged) Non-exporters Debt with FDI (unhedged) Lower regulatory limit
Jun-16 Dec-16 Jun-17 Dec-17 Jun-18
Non-exporters Debt (hedged) Exporters Debt
Local Currency Debt
*FX Market intermediaries: Includes credit establishments and brokerage firms.
24
Source: Banco de la República.
 2. A low pass-through, which is supported by a credible inflation targeting regime.
Despite the exchange rate depreciation in 2014, inflation expectations
remained close to the 3% target…
Inflation and Inflation Expectations
10%
Average of 1-Year Ahead Expectations
9%

8% Average of 2-Years Ahead

Expectations
7% Headline Inflation
6%

5%

4%

3%

2%

1%

0%
Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18 Mar-19

Source: Banco de la República – Monthly Survey of Economic Expectations

25
 3. Sufficient external buffers. A sufficient level of external buffers provides another
safeguard against external shocks. The Flexible Credit Line (FCL) by the IMF has
complemented the accumulation of international reserves…
International Reserves - Percentage of IMF's ARA Metric
180%

160%

Adequate level suggested by the IMF

140%

120%

100%

80%

60%

40%

20%

0%
Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Mar-19

26
Source: IMF and Banco de la República. The ARA Metric is updated yearly, the reserves quarterly.
 • A second policy implication is related to changes in natural interest rates
stemming from persistent shocks to terms of trade with strong effects on the
macroeconomy.
• Risk premia may shift persistently after a protracted terms of trade shock.

CDS and Terms of Trade 60% Debt of the Central Government

200,0% (% of GDP)
165%

48%
180,0%
50%
160,0%
Peru Colombia
140,0%
40%
120,0%

100,0%
30%

21%
80,0%

60,0%
20%
66%
40,0%
20,0%
10%
0,0%
Apr-14

Oct-14

Apr-15

Oct-15

Apr-16

Oct-16

Apr-17

Oct-17

Apr-18

Oct-18

Apr-19
Jul-14

Jul-15

Jul-16

Jul-17

Jul-18
Jan-14

Jan-15

Jan-16

Jan-17

Jan-18

Jan-19

0%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Colombian CDS (% of Peruvian CDS)
Colombian ToT (% of Peruvian ToT) 27