In a new report, Fitch Ratings argues that commodity prices are unlikely to escape a demand-led slowdown resulting from the anticipated global economic downturn.

This price slump is expected despite the spectacular rally prices have enjoyed over the first quarter of 2008. Nevertheless, Fitch says that prices probably will not fall by as much as in previous economic slowdowns and are likely to remain elevated relative to historical levels, “reflecting robust, albeit moderating demand from emerging markets”.

The report notes that from 2003 through 2007 all categories of raw materials have seen a surge in prices. This stands in contrast to historical experience, when price increases tended to be limited to a select few commodities. “Although the synchronised rise partly reflects the transmission of input costs through the supply chain, the increased correlation between different categories of commodities points to the role of a common demand shock, particularly from rapidly growing emerging markets,” it says, noting that China alone accounts for one-third of the incremental global oil demand and as much as 100% of the increase in demand for some base metals over 2002-2007.

Additionally, Fitch says the remarkable rise in oil and metals demand met constrained production capacity, resulting from weak investment in these sectors during the 1990s. Production has also been constrained by factors such as skilled labour shortages and resource nationalism. Meanwhile, food prices have risen due to a structural increase in demand.

Fitch reports that it sees little justification for the surge in commodity prices witnessed so far this year. It notes that a slowdown in OECD energy demand (60% of the total) is clearly already underway and likely has further to go in 2008, while it is reasonable to expect non-OECD energy supply to recover. “A weakening US economy, coupled with the forecast slowdown in Chinese GDP growth to 9.7% from 11.4% in 2007, the slowest in six years, is likely to take a further toll on metals demand. At the same time, investment in the metals sector has responded quite sharply, though the time lags to output are long,” it says.

The rating agency also suggests that it believes that temporary supply shocks have likely played a large part in recent food price increases. “With food supply typically more elastic in the short-term, this points to the likelihood that high food price inflation will prove less protracted than oil and metals inflation,” it concludes.