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The dual role played by commodities in construction

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Alex Carrick

Positions:
Alex Carrick is Chief Economist for Reed Construction Data. He specializes in economic forecasting and statistical services.

Economists

The construction industry is uniquely situated when it comes to commodities. The raw materials that are traded on international exchanges are base components of almost all building products. Construction material costs are heavily influenced by the change in the world price of oil, natural gas, copper, nickel, lumber, steel, cement and aluminum. But there is another side to commodity pricing for the building industry. Some of the largest construction projects in the country are driven by demand for and the price of raw materials.

Due to proximity and close ties between the two nations, the outlook for the Canadian economy has always depended to a marked degree on what is happening in the United States. That has been primarily a function of exporting manufactured goods to satisfy U.S. consumer demand. Even in the case of raw materials, investment has usually been to raise output in response to requirements from south of the border.

There is a new economic order, however, with emerging nations stepping into the limelight. As was seen in 2005 through 2007, activity levels in Western Canada surged ahead of the East due to resource sector growth. Much of this arose from investment in raw materials sites. The motivation was often to supply emerging nations and was spurred on by large price increases that contributed to corporate bottom lines.

The construction industry is uniquely situated when it comes to commodities. The raw materials that are traded on international exchanges are base components of almost all building products. Construction material costs are heavily influenced by the change in the world price of oil, natural gas, copper, nickel, lumber, steel, cement and aluminum. That’s the downside of commodity price increases for construction.

But there is another side to commodity pricing for the building industry. Some of the largest construction projects in the country are driven by demand for and the price of raw materials. This includes sawmills, mines, Oil Sands projects, pipelines, foundries and smelters.

The prices of globally-traded commodities are increasingly being determined by economic activity levels in China, Southeast Asia and India.

The state of the Chinese economy is of particular concern when it comes to commodity prices. In this year’s first quarter, China’s inflation-adjusted gross domestic product (GDP) grew at a double digit rate. To forestall the danger of asset price bubbles, the Beijing government has raised bank reserve requirements to rein in lending. Some analysts have worried that China’s growth may come to what has been termed a hard stop. The problems of Europe also factor in as that region is a customer of comparable size with the U.S. for Chinese products.

So far, the fears have been unwarranted. Chinese exports in May were 50% higher than in the same month a year ago. The inflation rate in May climbed to 3.1%, which is only slightly above the Bank of China’s 3.0% target for 2010 as a whole.

Further rapid change is coming. Tokyo-based Honda has granted a 24% pay hike to striking workers at a Chinese car parts plant. The copycat effect will see wages nationally rise by more than 10% annually for at least the remainder of this year, adding to inflationary expectations.

All the same, lifting incomes within China is important. It is part of the inevitable evolution that occurs as adolescent economies mature. There is a natural shift from investment and export-dependency to domestic-driven demand. A better balanced economy will make it easier to free the Yuan from its fixed link with the U.S. dollar. Freer floating currencies enable better capital allocations between countries.

In the meantime, continuing strength in the Chinese economy will mean ongoing momentum for commodity prices.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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