Today’s commodities watch offers some thoughts about the coming end of the Federal Reserve’s QE2 program and the effect that will have on commodity prices.  One could make a pretty good argument that the near-meteoric rise in some commodity prices which began late last summer were at least partly due to the $600 billion that the US Federal Reserve Bank decided to spend on buying US Treasuries. One could also argue that a substantial piece of that $600 billion was poured into commodities markets, especially oil, silver, gold, and copper.

The outflow of dollars to the big banks made possible purchases of futures and options, most of which were long and helped drive up commodities prices. What is likely to happen now that QE2 is nearing its termination date of June 30th?

Clearly the US economic recovery is in a stall. Unemployment is above 9% again and nearly every other recent measure of economic activity is down as well. When QE2 ends, there will be less liquidity available for non-commercial (speculative) activity in the commodity markets too. If that’s true, than commodity prices should decline, or at least not rise at such a breakneck pace.

The correction we saw in the commodities markets in the first half of May is being retraced, but, in the case of crude oil at least, only fitfully. Silver began the month of May at around $48/ounce and has still not made it back to $40. Gold is lower too, and so is copper.

Agricultural commodities have been volatile as well, but much of the volatility is due to projections of production, which have been rising and falling on weather forecasts and additions to global supplies.

Russia’s decision to begin exporting wheat again, for example, has taken a good deal of the steam out of wheat’s price recovery. Corn prices have recovered to near April highs due to planting difficulties in the US related to cool, wet weather.

The end of QE2 is likely to continue moderating the rate of price increases for commodities, especially oil and some metals. That should help stabilize prices and lower the threat of significant inflation. Whether the end of QE2 will have any impact on unemployment remains to be seen, but that depends to a large extent on what happens to oil prices.

A drop in oil prices to around $90/barrel could provide a nice boost to the US economy. That boost, if it comes, will benefit consumers, not investment banks with cheap money to play with. And maybe it will last longer than a few months too.

Paul Ausick

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