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Commodity prices are gradually improving, according to Scotiabank’s Commodity Price Index. In June, the index, which measures price trends in 32 of Canada’s major exports, climbed by 5.1% month-over-month — the second month of consecutive gain.

Continued demand by China, better-than-expected U.S. corporate earnings in the technology sector and signs that the U.S. recession may be nearing an end are some of the reasons cited for the rise in prices.

According to Scotiabank, while U.S. industrial activity was weak in June, partly on account to the downsizing in the auto-sector, a scheduled ramp-up of motor vehicle assemblies in the third quarter will boost steel and metal-intensive activity.

“Production will improve substantially from the first half of 2009, when assemblies were cut in half,” says says Patricia Mohr, vice-president, economics and commodity market specialist at Scotiabank. “Sentiment in U.S. financial markets for a moderate recovery in U.S. metal and steel demand will likely improve noticeably through the third quarter.”

For two straight months the oil and gas index has been leading the way, climbing by 12.2% in June. Oil prices have experienced moderate fluctuations alongside expectations of economic recovery.

West Texas Intermediate crude jumped from $59.21 US per barrel in May to a high of $73.38 on July 3, before falling back to a low of just over $58 on July 17. However, prices have rallied back to the $65 mark in recent days with reassurance that U.S. economy is on the road to growth.

Canadian natural gas prices are expected to increase due to shorter supply.

“While natural gas prices should rally in the next six months, as this year’s plunge in drilling activity eventually cuts U.S. output, the lower cost curve for the industry suggests a lower trend price for natural gas going forward,” says Mohr.

The metals and mineral index was up 4.7% in June and is expected to strengthen with growth in China and improvement in U.S. market.

“The significant pick-up in China’s economy and industrial activity in the second quarter, improving G7 auto sales, the beginning of a recovery in U.S. housing starts and a weak U.S. dollar have recently lifted prices,” says Mohr. “Contrary to expectations, China’s copper imports rose to another record high in June.”

A modest recovery in U.S. housing helped boost the forest products index, pushing it up by 1.6% month-over-month.

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Deficit will be easy to beat: CIBC

Canada will have better handle on its deficit and will not be as heavily burdened with debt servicing as it was 20 years ago, according to a report out of CIBC. The report questions gloomy forecasts over the impact of budget deficits in Canada.

“Canada’s fiscal standing is hardly at risk,” said chief economist Avery Shenfeld and senior economist Warren Lovely.

Both Shenfeld and Lovely note that fiscal projections often understate the potential to tackle deficit challenges, and relatively small errors in future growth estimates can throw medium-term deficit projections wildly off the mark.

This was the case following the early 1990s recession when “large surpluses seemed like a fairy tale.” Instead, the pair write, the $37.5 billion deficit “was erased at a breakneck pace” and transformed into a $3 billion surplus in three years “as the business cycle swung to expansion and a ‘jobless recovery’ eventually gave way to more serious hiring and income growth.

Another vital factor is that nearly all the deficit incurred in the 2009-2010 budget was cyclical and that government stimulus efforts are temporary. Accordingly corporate profits and rising incomes will have a large role in creating budget surpluses, as in the past.

If commodity prices rebound as expected, that could mean another material improvement to federal fortunes.

Even if fiscal progress is slow and deficits prove hard to erase, erasing the deficit will be easier than in the past, thanks to lower debt service costs.

“Over a 15-year period from 1982 to 1997, debt service was equivalent to fully one-third of federal revenue,” note Shenfeld and Lovely. “Today that interest burden has fallen to just 13% versus total revenue.”

The pair also said that any remaining deficit after five years will be small enough that the debt to GDP ratio will fall, minimizing the government’s need to issue debt.

In 1993, the Wall Street Journal dubbed Canada an honourary member of the Third World. “This time, The Wall Street Journal will be comparing the U.S., not Canada, to banana republic debtor nations,” added Shenfeld and Lovely.

(07/23/09)