Inflation clouds forward commodity outlook

John Kemp is a Reuters columnist. The views expressed are his own

canada goose By John Kemp

Canada Goose Parka LONDON (Reuters) When futures Canada Goose Online markets were first created and theories about forward pricing were developed prior to the 1940s, contracts did not extend more than a few months into the future and the general price level had been generally stable uk canada goose (trend free) over long periods of time (decades in some instances). The impact of inflation on future prices could be safely ignored.

canadian goose jacket But with contracts lengthened to as much as a decade, in a world characterized by persistent inflation since 1945, inflation has become the buy canada goose jacket cheap dominant factor in forward pricing.

The basic problem is that futures contracts are fixed in nominal terms while producers, consumers and investors care about real post inflation values.

The attached charts show oil prices since canada goose black friday sale 1990 and how prices would look in nominal terms over the next 10 years using different starting assumptions ($134 per barrel, $104 and $57) and applying different average rates of inflation (5 percent and 2 percent) or deflation ( 2 percent).

canada goose clearance sale For a canada goose uk shop market user thinking of buying or selling a far forward futures contract, there are now two sources of uncertainty, which compound one another:

(1) What is the baseline canada goose clearance real oil price needed to Canada Goose online balance the market, now and in future, and how will this change?

Canada Goose Jackets There is no consensus about what level of real prices will be canada goose uk black friday needed to balance supply and demand over the longer term, and whether it will be broadly static, or rise and fall with the changing dynamics of the petroleum economy.

cheap Canada Goose (2) What inflation rate should be used to convert Canada Goose Outlet this real baseline price into nominal far forward cheap Canada Goose prices?

canada goose coats The appropriate nominal price to pay for far canada goose online forward futures contracts is enormously sensitive to the assumed rate of inflation.

Canada Goose sale For example, assume a real balancing price cheap canada goose uk of $104 (which was the average in Sep, after the cyclical peak in Jul 2008 but before the recent price plunge) that remains constant for the next decade.

buy canada goose jacket Applying different canadian goose jacket inflation rates could give an equivalent nominal price in Dec 2018 of as high as $171 per barrel (in a world with 5 percent inflation), $127 (in a world of 2 percent inflation) or as low as $84 (in a world of 2 percent deflation).

In fact, under reasonable assumptions about real oil prices taken from Jul ($137), Sep ($104) and Nov ($57) this year, and realistic projections of the inflation canada goose factory sale rate (5 percent, 2 percent and 2 percent), nominal canada goose uk outlet spot prices Canada Goose Parka could be as high as $225 in Dec 2018 or as low as $45.

In many instances, assumptions made about inflation dominate assumptions made about real balancing prices.

Canada Goose online Risks from miscalculating inflation over long periods are at least as important as risks arising from mistiming market entry and exit.

canada goose deals INFLATION AND THE CONTANGO In theory, inflation impact should be captured within the term structure of interest rates and the resulting cost of carry, hence the shape of the forward curve.

But that assumes credit markets are able to forecast future inflation rates accurately and forward interest rate markets give efficient, unbiased and accurate forecasts not distorted by temporary cyclical fluctuations, manias and central bank intervention.

In effect, relying on canada goose clearance sale the forward interest rate uk canada goose outlet curve simply transforms one problem (the forecasting efficiency of commodity futures markets) into another one (the forecasting efficiency of money futures markets).

From Canada Goose Coats On Sale a practical standpoint, there are good reasons to question whether commodity futures markets have been offering Canada Goose sale adequate protection canada goose store from inflation.

In Jul 2008, when oil prices and concerns about worldwide inflation were peaking, Dec 2016 oil prices were canada goose coats on sale just $2 per barrel higher than those for Dec 2008 (an annual rise to compensate for inflation of only 0.3 percent per year).

buy canada goose jacket cheap Five months later, with inflation fears receding and nervousness about deflation, Dec 2016 barrels are trading at more than $40 over Jan 2009 (a massive premium of 10 percent a year).

Clearly the forward curve offered least inflation compensation just when it was most needed, and most canada goose when it was least important.

canada goose clearance Other factors, particularly the cost of credit and the outflow of investment money, explain changing curve patterns. But it is clear that nominal forward prices have not offered investors or producers much compensation for inflation risks.

INFLATION OR DEFLATION? If anything, uncertainty about future inflation has increased substantially since the summer.

canada goose black friday sale Investors and the Federal Reserve are now openly worried the credit crunch could usher in the deepest and most prolonged recession since 1980, buy canada goose jacket or even the 1930s, tipping the economy into a period of deflation akin to Japan in the 1990s if not as bad as the United States before 1939.

canada goose coats on sale But the Fed aggressive response (quantitative easing and money creation) plus the federal government canada goose coats growing mountain of debt has caused a minority of commentators (by no means irrational) to take the opposite view, forecasting a new era of Canada Goose Jackets faster inflation in the medium term once the immediate crisis is passed.

It is not clear how forward commodity markets should respond.

Canada Goose Outlet Should the market price in recovery and faster inflation? In which case forward prices need to trade at a very substantial premium, to account for both faster inflation and a pick up in the underlying price to a more reasonable long term level.

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