Commodity Prices and Global Economic Activity: a derived-demand approach

In this paper, a derived-demand approach is proposed to explain the positive correlation and the synchronicity between the growth rates of commodity prices and of economic activity at the global level. The focus is on important traded commodities, whose supply function is very price inelastic in the short run, such as oil and major metal commodities. The paper contributions are as follows. First, the synchronicity of oil-price and global activity cycles is presented using the tools of the common-feature literature. Second, it is shown how to improve forecasts of global activity using commodity prices, noting that one observes the latter at an almost continuous-time basis, but the former at a much lower frequency and with considerable delay. Third, the usefulness of optimal forecast combinations for oil prices is discussed employing a wide array of macroeconomic and financial variables. The out-of-sample R2 statistic for model combinations can reach up to about 14%, a major improvement over the previous literature.