This is a post from Alex Carrick's blog that covers the Canadian construction industry.

Since 1985, Mr. Carrick has held the position of Canadian Chief Economist with Reed Construction Data's CanaData, the leading supplier of statistics and forecasting information for the Canadian construction industry.

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Notes from Alex Carrick - Jul 06, 2011

Alex Carrick
A shakier world outlook explains the easing in commodity prices

The health of Canada’s economy largely depends on two factors: 1) the strength of the U.S. economy; and 2) global demand for commodities and the resulting impact on their prices.

The former determines Canadian exports to the U.S. The latter sets the pace of sales in the resource sector and spurs on mega project investment.

At this time, the recovery from the world economic recession is still moving forward, but on unsteady legs. There are many reasons to believe in a shakier outlook.

Let’s start with emerging nations.

China is in a race to rein in its inflation rate before it becomes viral. The latest year-over-year gain in the overall price level in that country was +6.0%, led by a food sub-index that rose at a double-digit percentage rate year over year.

The upshot has been another increase in interest rates, the third this year. A substantial appreciation in the value of the yuan would help lower import prices, but that’s not likely to happen.

There are too many worries about how that might make the slowdown in Chinese growth more pronounced by reducing export sales.

China isn’t without its own problems. Labor costs have been rising and some other countries in South East Asia offer considerably lower costs of production (e.g., Vietnam). Even Chinese firms are outsourcing some of their work.

The property price bubble has become alarming in some cities. There are signs it may be starting to dissipate. The question now becomes whether or not the steps taken by Beijing on the monetary side may become too restrictive.

The worry is that China may suffer a harder landing than desirable. In actual fact, a “real” (after-inflation) growth rate of 5.0% or less would qualify as a hard landing for China.

In Europe, monetary authorities believed they’d come up with a plan to rescue Greece from its latest round of financial disaster. But the rating agency, Standard & Poor’s has thrown a monkey wrench into the proceedings.

S&P has suggested that “voluntary rollovers” of debt by private lenders might be considered a technical default situation, triggering insurance payments under credit default swap provisions. The International Swaps and Derivatives Association may be forced to make a ruling.

In the meantime, Greece isn’t the only EU nation in fiscal trouble. Moody’s Investors Service has just downgraded Portugal’s government-issued paper to junk bond status.

The U.S. economy was charging out of the gate for a while but then fell into the mud. This was brought on primarily by high gasoline prices and ongoing problems with both the housing and labor market segments.

The housing market is a particular morass. Lending standards were clearly too lax before the recession. Sub-prime mortgages attracted too many buyers into the housing market who weren’t able to keep up mortgage payments once interest rates moved up in 2005-2006.

Fannie Mae and Freddie Mac subsequently required federal government intervention to stay afloat. In reaction, those two entities are now exercising extreme caution when it comes to lending.

Higher credit scores and bigger down payments are two measures making borrowing more difficult.

Potential homebuyers who, according to most reasonable measures of credit-worthiness, should be receiving approval for loans are being turned down.

Setting aside the couple of years when sub-prime mortgages were common, lending standards have been tightened beyond what has historically been in place. There are lots of willing home purchasers who are being denied the chance, seriously holding back the pace of the recovery.

There has to be some easing of credit standards in the mortgage market. It’s hard to see how the
U.S. economy can extract itself from the mire without a more vibrant housing sector.

All of the foregoing is offered as an explanation for why commodity prices have eased back in the last month or two.

At the end of June, the Bank of Canada’s (BOC) total commodity price index was 10% down from its most recent peak in early May. That still left it two-thirds higher than its recessionary trough level in February 2009.

Commodity prices peaked in July 2008. They were elevated to that level by world oil prices that reached an all-time high. The BOC’s index currently sits about half-way between its most recent peak and trough.

The BOC’s index, exclusive of energy, has turned in a more impressive performance of late. In May, it rose to a record level. Even after backsliding in the latest month, it stands above its previous peak in mid-2008.

Since the recession, the energy index has been held back by low natural gas prices. There was an upward blip in oil prices brought on by the Arab Spring, but that has partially vanished with the onset of the world economic slowdown.

The forestry products price index now lies about where it was, on average, throughout the period 2004 to mid-2008. Nor is it likely to move upwards much until the U.S. returns to stronger growth and American housing starts make a comeback.

It’s been agricultural prices, at new record highs, and metals and minerals prices, back near their all-time spikes in early 2007 and early 2008, which have been setting the pace for the Bank of Canada’s overall commodity price index.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.


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Read Other Recent Alex Carrick Posts

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