We have been reporting
on the trade-off between the producer price index of crude oil (domestic
production) and the PPI of iron&steel since 2009. It has been always a
linear and lagged link between them. Our
previous update included PPI data through March 2012. Here we present an annual
wrap-up.
We reported that the PPI
of crude oil had been likely evolving in sync with that of iron and steel, but
with a lag of two months in September 2009.
In order to present both indices in a comparable form, the difference
between a given index, iPPI (i.e. iron&steel
and crude), and the overall PPI was normalized to the PPI: (iPPI(t)-PPI(t))/PPI(t). These normalized differences represent the
evolution of the rate of deviation from the PPI over years.
Figure 1 depicts the corresponding
time histories of the normalized deviations from the PPI, including the most
recent period through August 2012. Even
a simple visual inspection reveals the following feature: the (normalized
deviation from the PPI of the) index of iron and steel lags by approximately two
months behind the (normalized) index of crude oil.
Figure 1. The deviation
of the iron and steel price index and the index of crude oil from the PPI,
normalized to the PPI.
In order to reduce both
deviations to the same scale we additionally normalized the curves in Figure 1
to their peak values between 2005 and 2012.
(iPPI(t)-PPI(t))/[PPI(t)*max{iPPI-PPI)}]
This scaling allows a
direct comparison of corresponding shapes. In Figure 2, we display the
normalized index of iron and steel shifted by two months ahead to synchronize
its peak with that observed in the normalized index for crude petroleum. The scaled
index of crude demonstrates just short-term deviations from the index of iron
and steel in the overall shape and timing of the peak and trough. Simple
smoothing with MA(3) makes the curves resemblance even better. As an extra
benefit of the resemblance, one can use the two-month lag to predict the future
of the iron and steel price index.
Figure 2. Deviation
of the iron and steel price index from the PPI, normalized to the PPI and the
peak value after 2005 as compared to the deviations of the index for crude
petroleum normalized in the same way. The normalized index for iron and steel
is shifted two months ahead.
Conclusion
The link between oil
and iron has been unbreakable. Between 2006 and 2012, the deviation of the price index of
iron and steel from the PPI in the USA repeats the trajectory of the deviation
of the index of crude petroleum (domestic production) with a two-month lag.
Therefore, the prediction of iron and steel price for at this horizon is a
straightforward one.
