Commodity prices and global economic activity: A derived-demand approach

We propose a derived-demand approach to explain the positive correlation and the synchronicity between the growth rates of commodity prices and of economic activity at the global level. Our focus is on important traded commodities, which supply function is very price inelastic in the short run, such as oil and major metal commodities. Our contributions are as follows. We first show the synchronicity of oil-price and global activity cycles using the tools of the common-feature literature. Second, we show how to improve forecasts of global activity using commodity prices, noting that we observe the latter at an almost continuous-time basis, but observe the former at a much lower frequency and with considerable delay. Third, we show the usefulness of optimal forecast combinations for oil prices 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.