1 of 16

Comments on��DIRK BAUR �“COMMODITY PRICES, CURRENCIES AND THE LAW OF ONE PRICE”

by

Ken Clements*

Business School

The University of Western Australia

April 2017

*I thank Long Vo and Jiawei Si for helpful discussions and suggestions

2 of 16

OVERVIEW OF PAPER

  • Link between exchange rates and world commodity prices
  • Regressions of commodity prices on exchange rates
  • Uses (i) US dollar bilateral and multilateral rates and (ii) same for other major currencies
  • Tests if dollar appreciation leads to fall in commodity prices
  • Causality tests
  • Integration of commodity and currency markets

2

3 of 16

SUMMARY OF RESULTS

  • Data: Daily returns for 35 years up to 2015

​

​

  • Test
  • Estimated slopes in range [-1, 0]
  • Slopes with monthly data < daily. Takes time to adjust

3

4 of 16

SUMMARY OF RESULTS

  • Ranking of estimated slopes:
    • Precious metals (gold!)
    • Industrial metals
    • Energy
    • Agricultural commodities
  • Ranking by country for average slopes also

​

4

5 of 16

POSSIBLE USES

  • Portfolio analysis – exchange rates as common factors in driving commodity prices (investing in mining companies, etc.)
  • Project evaluation – in feasibility studies for gold projects can’t make forecasts of prices independently of ER forecasts
  • Pricing power – which countries dominate the market

​

5

6 of 16

INTERPRETATIONS

  • Estimated slope
  • Impediment to trade, failure of law of one price
  • Price of BMWs in Oz unaffected by $A
  • Suppose LOP holds for wheat:

​

​

​

6

7 of 16

WHICH PRICE CHANGES?

  • When $A depreciates by 10%,

​

​

​

​

​

​

​

  • Takeaway: does not contradict the LOP

​

7

45°

-0.10

0.10

A

B

0

8 of 16

DEPRECIATION OF $A

8

​

​

​

​

​

​

W

W

R

E

R′

E′

9 of 16

PRICE TAKER

  • For small country, world price remains constant and internal price rises by the full amount:

​

9

W

W

R

E

R′

E′

10 of 16

PRICE MAKER

  • For a large country, world price falls by the full amount of the depreciation, while the internal price remains unchanged:

​

10

W

W

R

E

R′

E′

11 of 16

POSSIBLE SOLUTION

  • Instead of using

​

  • Replace dependent variable with the relative price change:

​

  • Then test

​

​

11

12 of 16

THANK YOU

12

13 of 16

WORLD MARKET

13

Excess supply

A

B

C

14 of 16

  • Call this the WW schedule (to recognise that it represents equilibrium in the world market):

​

14

W

W

15 of 16

ADD LOP

15

W

W

R

E

16 of 16

GENERAL PRINCIPLE

16

Producers of a commodity dominated by a country whose currency dominated by a country whose currency depreciates will be worse off. Vice versa for an appreciation.