Commodities Fundamental Model

Copper price is fundamental for the Chilean economy and, thus, for the Central Bank of Chile’s forecasts. The goal of this document is to provide a theoretical tool that allows not only to understand the determinants of the evolution of copper price, but also forecast it. We define isoelastic demand and supply functions with both temporary and permanent shocks. We also allow for inventory storage based on a non-arbitrage condition with respect to expected prices. We use a shooting algorithm to solve for equilibrium with rational expectations, with supply, demand, and inventory data as inputs. We also isolate the USD exchange rate component of copper prices. We find that in the short run, temporary shocks play a minor role, whereas the USD Broad index and expectations contribute significantly. Also, in the long run, permanent demand and supply shocks seem to explain the major dynamics. We also present suggestive evidence that imprecise information can explain short-run volatility in expectations. Likewise, the model and methodology used are applicable to any storable commodity, assuming that supply, demand, price and inventories data are always available.