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Jörg Mayer Division on Globalisation and Development Strategies UNCTAD Study Tour for Russian Member Universities of the Vi Network Geneva, 5 April 2011 Recent commodityprice developments and financial investors
Main points • Recent commodity price developments have been driven by both fundamentals and financial investment • Financial investment in commodity markets has undergone two substantial changes in past decade • 2002–2008: sizeable increase in level, particularly in form of broad-based passive index investment • Since 2008: increasing importance of more sophisticated and narrowly targeted active investment • Price volatility indicates uncertainty and has adverse effects at both macroeconomic and microeconomic levels • Main policy recommendations: • Greater transparency across physical, futures and OTC markets • Tighter regulation (clearing for standardized OTC-contracts, speculative position limits, provisions regarding HFT) • Increased investment for sustained physical supply growth
Overview • Price trends and volatility: recent evidence and underlying factors • Financial investment in commodities – an impact on prices? • Why does price volatility matter? • Policy measures addressing rising prices, rising price volatility, and financialization • Conclusions
1. Evidence on price trends Commodity prices have surged over past few months reaching (or exceeding) 2008-levels Commodity prices, selected groups, Jan 2005–Feb 2011, index numbers. 2000=100
Evidence on price volatility Price uncertainty for many agricultural products has increased and remains high Conditional price volatility of wheat, 1995–2010
Factors behind recent price developments • Is there a new commodity super cycle? • Depreciation of US-dollar • For food, low stock-to-use levels, link between energy and food prices (agricultural inputs, biofuels, financial index-based investment), as well as climatic factors and ad hoc policy measures • Role of financial investors
2. Financial investment in commodities • Financialization refers to the increasing role of financial motives, markets and actors in the operation of commodity markets • Financial investors look at commodities as an asset class (just like equities, bonds or currencies) and enter commodity markets to diversify their portfolios • Deregulation and financial innovation have been facilitating factors
Recent evidence on financial investment Financial investment in commodities is at historic high – and its composition has changed significantly Commodity investment data by product, assets under management, 2005–2010 ($bn)
Financial investment and the real economy The ratio of financial investment in commodities to world GDP has strongly increased The ratio of assets under management to world GDP, 2005–2010 (%)
Financial investment not just tale of index traders Prices and net long financial positions by trader category, selected commodities, June 2006–February 2011, price per unit and number of futures and options contracts ('000) C )
Financial investment – impact on prices? • Speculators are indispensable for functioning of exchanges (risk transfer risk, price discovery) • Alleged ‘logical inconsistencies’ (Irwin/Sanders): • Financial traders neither hold futures contracts up to expiration and participate in the delivery process where, allegedly, price discovery takes place nor hold physical inventory • Krugman: where are the inventories? • Informed traders would do arbitrage • In 2007-8, commodities not included in broad-based indexes experienced similar price increases
Regression analysis shows that index- based investors amplified 2008-price spike Source: C Gilbert (2010), Speculative influences on commodity futures prices 2006–2008, UNCTAD Discussion Paper No 197.
3. Why does price volatility matter? • Macroeconomic level: • Uncertainty curtails investment and depresses growth • For net commodity exporting (importing) countries, price collapses (spikes) cause balance-of-payments problems and deteriorating public finances due to lower revenues (higher expenditures) • Microeconomic level: • high and volatile prices have severe impacts on the most vulnerable in food- and energy insecure households • Price volatility makes hedging more expensive and risky
4. Policy measures addressing rising prices and price volatility … • ‘High prices are best cure for high prices’ - incentives • Long-term: increase in productivity, sustainability and resilience of agriculture (ODA, technology transfer, links with climate change) • More flexible biofuel mandates (allow reduced mandated levels when rising food prices warrant) • Review trade policies related to food security • Food import financing facility
… and financialization • Improve transparency on physical, futures and OTC-markets and harmonize regulation • Debate (US, EU) on clearing of standardized OTC-contracts, speculative position limits, provisions for high-frequency trading, and limit misuse of information (Volcker rule) • What can other countries do? • Weather-based derivatives • Hedging with futures and options contracts • Creating their own commodity exchanges
5. Conclusions • Commodities have acquired dual nature as physical commodities and financial assets • Debate on price impact of financial investment remains – data problems, myriad of other influences • Consensus that (food) stocks need to be rebuild, supply expanded, and transparency improved for physical and paper trading • Much of planned regulatory reform in US and EU concerns wider context of financial sector stability
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Some terminology (1) • Exchange: A central marketplace with established rules and regulations where buyers and sellers meet to trade futures and options contracts or securities. • Futures Contract: An agreement to purchase or sell a commodity for delivery in the future: (1) at a price that is determined at initiation of the contract; (2) that obligates each party to the contract to fulfill the contract at the specified price; (3) that is used to assume or shift price risk; and (4) that may be satisfied by delivery or offset. • Option: A contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of a commodity or other instrument at a specific price within a specified period of time, regardless of the market price of that instrument. • Over-the-Counter (OTC): The trading of commodities, contracts, or other instruments not listed on any exchange.
Some terminology (2) • Hedger: A trader who enters into positions in a futures market opposite to positions held in the cash market to minimize the risk of financial loss from an adverse price change; or who purchases or sells futures as a temporary substitute for a cash transaction that will occur later. One can hedge either a long cash market position (e.g., one owns the cash commodity) or a short cash market position (e.g., one plans on buying the cash commodity in the future). • Speculator: In commodity futures, a trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements. • Speculative Bubble: A rapid run-up in prices caused by excessive buying that is unrelated to any of the basic, underlying factors affecting the supply or demand for a commodity or other asset. Speculative bubbles are usually associated with a "bandwagon" effect in which speculators rush to buy the commodity (in the case of futures, "to take positions") before the price trend ends, and an even greater rush to sell the commodity (unwind positions) when prices reverse.
Some terminology (3) • Commodity index investment is activity typically characterized by a passive strategy designed to gain exposure to commodity price movements as part of a portfolio diversification strategy. Exposure to commodity price movements can be based on investment in a broad index of commodities, a sub-index of related commodities, or a single-commodity index. • A money manager is a registered commodity trading advisor (CTA); a registered commodity pool operator (CPO); or an unregistered fund identified by CFTC. These traders are engaged in managing and conducting organized futures trading on behalf of clients.