PPI of metals on decline

This is a regular revision. We have been following the evolution of several price indices of metals since 2008. Our general approach is based on the presence of long-term sustainable (linear and nonlinear) trends in the evolution of the CPI and PPI in the United States [1, 2]. The difference between various components of these indices is not a random one but is rather a predetermined process. Using these trends, one can predict consumer and producer price indices for select goods, services and commodities.  

In this post, we revisit the trends in the PPI of three commodities related to metals: steel and iron and nonferrous metals. Originally, we reported on these items in 2008 and then revisited in 2010 and February 2012. We expected the index of steel and iron to return to the long term trend, which express a higher rate of growth of the producer price index than that of steel and iron. The index of nonferrous metals had to fluctuate with large amplitude around the PPI and grew at a lower rate than PPI during 2012.  

1.     Figure 1 compares the difference between the PPI and the index for iron and steel (101). The difference is characterized by the presence of a sharp decline between 2001 and 2008. Between 1985 and 2000, the curve fluctuates around the zero line, i.e. there was no linear trend in the absolute difference. Our main assumption was that the negative trend observed before 2008 should start transforming into a positive one after 2008. In Figure 1, the (expected) new trend is shown by green line. This trend suggests that the PPI grows faster than the index of steel and iron by approximately 2 units of index per year. Figure 2 demonstrates the most recent period and confirms that our prediction for 2012 was correct – the difference has been approaching the green line. One may foresee the difference to intersect the green line in the near future as a (pendulum) return motion. The index of steel and iron will likely be falling in absolute terms in the fourth quarter of 2012 and the first quarter of 2013.  

2.     The index for non-ferrous metals (102) shows an example of the absence of sustainable trends in the difference (see Figure 3). The curve is rather a comb with teeth of varying width. Although varying, the distance between consecutive troughs is several years at least. In February 2012, we expected this index to decrease relative to the PPI and the difference in Figure 3 to rise to the level of -10. This prediction is still valid but the difference has gained only 18 points since February (from -62 to -44). Considering the observation that the rate of growth was approximately 3 points per month since February 2012 one may expect the level of -10 in approximately 10 to 12 months, i.e. in September 2013.  The price of nonferrous metals will be decreasing in absolute terms as well.

 

Figure 1. The difference of the PPI and the index of steel and iron updated for the period between January 2012 and August 2012. As expected, the difference has been increasing during the reported period and closed the new trend (green). The price index for iron and steel will be growing at a lower rate than the overall PPI.    

Figure 2. The evolution of the difference between the PPI and the price index of iron and steel between January 2005 and August 2012. Green line predicts the evolution of the difference after 2008. Red circles represent the difference between April 2009 and August 2012.  

Figure 3.  The evolution of the difference between the PPI and the index of nonferrous metals from 1985 and August 2012. There are no linear trends in the difference, but its behavior demonstrates a clear periodic structure with relatively deep but short troughs.  

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The S&P 500 returns imply real GDP growth 4% in Q3

We have been following the link between the S&P 500 and real GDP since 2008, when the first version of our S&P 500 quantitative model was published. We revisit our prediction on a regular basis and calculate a new forecast. Last time, we discussed the model on February 5, 2012 and reported a good prediction for the prior period. Here, we update our model with the revised GDP estimates and include the advance GDP estimate for the third quarter of 2012.  The monthly closing prices through September 2012 are used.  

As discussed in our working paper on the S&P 500 index, there exists a trade-off between the growth rate of real GDP, G(t),  and the S&P 500 return, R(t). The predicted returns, R_p(t), can be obtained from the following relationship: 

R_p(t) = 0.0054dlnG(t) - 0.03   (1) 

where G(t) is represented by the Q/Q (annualized) growth rate, because only quarterly readings of real GDP are published by the BEA.   Figure 1 compares the observed and predicted returns through September 2012. The third quarter of 2012 is characterized by a rapid rise in the level of the S&P 500 index and its returns over the previous 12 months. The real GDP estimate for the third quarter will be available in approximately two weeks, but one may estimate this value from the S&P 500 returns using (1). Three red diamonds in Figure 1 represent the predicted growth in the returns for the (annualized) GDP growth rate of 4%.  

Therefore, the stock market index indicates the growth rate of real GDP above the consensus estimate for the third quarter. Our estimate is also supported by the fall in the rate of unemployment to 7.8% in September from 8.1% in August, which corresponds to the GDP growth rate above 3% per year.

 

Figure 1. The predicted and observed S&P 500 return.  The predicted curve is smoothed by MA(4). The 12-month S&P return observed during the third quarter of 2012 implies the real GDP growth rate of 4%.

Spain: 33% unemployed in 2013?

A year ago, we described the evolution of unemployment in Spain using the LSQ technique as applied to the integral version of Okun’s law: 

 

u(t) = u(t₀) + bln[G/G₀] + a(t-t₀)  (1)  

where u(t) is the rate of unemployment at time t, G is the level of real GDP per capita (we used TED, Conference Board, EKS PPP ), a and b are empirical coefficients.   The best-fit (dynamic) model for Spain minimizing the RMS error of the cumulative model (1) is as follows: 

du = -0.406dlnG + 2.00, t<1995

du = -1.11dlnG + 1.54, t>1994    (2)  

This model suggests a big shift in the slope and a smaller change in the intercept around 1995. Having a new unemployment estimate for 2011, we have updated Figure 1 (original Figure 1) from our previous post and confirmed the excellent predictive power of the model. The predicted value is 21.4% and that borrowed from the U.S. BLS is 21.8%.  

Figure 1 also shows a prediction (red circle) of the unemployment rate in Spain in case of a 10% fall in real GDP per capita in 2013. The current economic performance in Spain is awful and some experts see a GDP fall of 25%. We are scared to publish the number for the fall by a quarter of the current GDP level since even a 10% fall will result in a 33% rate of unemployment. Essentially a one third of labor force will be unemployed.  Unfortunately, even a zero GDP growth rate will result in a 1.5% increase in unemployment (see eq. 2).

Figure 1.  The observed and predicted rate of unemployment in the Spain between 1971 and 2011. 

In 2013, the rate may reach 33% in case of 10% fall in real GDP.  

The cumulative form of the dynamic Okun’s law is characterized by standard error of 1.68% for the period between 1971 and 2011 (0.92% after 1995). The average rate of unemployment for the same period is 13.6% (14.6% after 1995) with a standard deviation of the annual increment of 2.12%.

Russia: an economic projection from IMF

International Monetary Fund has issued a new "World Economic Outlook".  This is a sixty page document with lots of tables and figures. For Russia, it's not too much reported. IMF expects the Russian GDP to grow by 3.7% in 2012 and by 3.8% in 2013. This is 0.3% and 0.1% less than was predicted in July. A sad trend which may extend in the future.  Economic "activity in Russia, which has benefited various economies in the region, has also lost some momentum recently."
Central Bank Total Assets increased to 50% of the 2008 GDP, which is less than in China but higher than in India and Brazil. An important value for Russia is the difference between global oil demand and supply. With the Russian 10.7 million barrels production per day the global production excess in 1.7 millions a day (supply is 90.1 and demand - 88.1). Oil price has a downward tendency.

On the limits of economic growth

The discussion of the growth limits frightens the public. The perspective to have no growth in the near future puts the lives of our children under a great danger of having no work and fun. It is really frightening. This assumption comes from the theory of economic growth based on technological progress as the driver of real GDP. Since the inception, the technology and its progress has been mainly associated with the production of goods. The portion of workforce and capital needed to produce all goods for a given society has been decreasing over time due to millions and millions scientific inventions and major breakthroughs in engineering. When this tendency is extended years ahead one may suggest that the production of goods will require just a handful of people and a fraction of capital.

The frightening thing – this tendency does exist. Figure 1 shows the evolution of a few ratios: the portions of services and goods (also split into durable and non-durable goods) in the U.S. gross domestic product. The portion of goods in the GDP has been declining since 1951, which is the start year of our graphs. The portion of durable goods is constant (around 10%) since 1951. The fall in the goods portion is chiefly related to non-durable goods. The rate of fall has been decelerating since the start of the 1980s.

The portion of services in the GDP has been growing along a linear trend since the beginning and is about 47% in 2012. There is some room for the further growth in the 21st century. The portion of goods may decline to 25% of the GDP. Currently, the deceleration in the fall of the nondurable goods portion is explained by the increasing share of the PCE in the GDP, as Figure 2 demonstrates. This increase is compensated by a falling portion of the government consumption expenditures and gross investment.

Extrapolating all trends in the future, one may assume that there is no danger to the growth in real GDP which is defined the growing portion of services, which include not only technological progress per se but also human resources. As long as Humans have personal creativeness to please other Humans real economic growth is not in danger.

Figure 1. The portions of services and goods in PCE.

Figure 2. The portion of PCE in GDP

New issue of Theoretical and Practical Research in Economic Field

A new volume of TPREF (the whole journal as a pdf file ) is available now for Summer 2012. I am an author of one article and a co-editor.

A Closed Form Solution for a Growth Model with Externalities and Public Spending Oliviero A. CARBONI Paolo RUSSU University of Sassari, Italy	… 4
The Government-Taxpayer Game David CARFI University of California at Riverside, USA Caterina FICI Business Administrator at VF of V. Fici, Italy	… 13
Modeling Unemployment and Employment in Advanced Economies: Okun’s Law with a Structural Break Ivan KITOV Institute for the Dynamics of the Geospheres, Russia Oleg KITOV University of Oxford, UK	… 26
Knowledge-Based Economies and the Institutional Environment Daniele SCHILIRÒ University of Messina, Italy	… 42