News
BackCauses and solutions concerning the increasing volatility and the rising levels of prices for raw materials and food products were the main topics at the conference “Commodities and Raw Materials: Challenges and Policy Responses”, which the Commission had staged on Tuesday. Increasing demand and speculation
Since the beginning of this century we have seen the price for crude oil rising from 20$ to over 140$ in 2008; then it plummeted to 40$ per barrel within a period of only six months. “Yes, there was less demand and more supply; but this can’t happen within six months. You can't tell me that this is a perfectly functioning market”, countered French President Nicolas Sarkozy some discussion participants at the Conference, such as David Peniket. The President of ICE Futures Europe (one of the largest energy futures and options exchanges) said that the price development and the rising volatility of the prices would not be the result of speculation, but the development of demand and supply. “Future markets and OTC markets play an important role in price identification”.
Over the past years, not only the oil price has been more and more volatile but also food prices. In 2008, the price per ton of wheat rose to 450$ (from previously 200$), fell then back to below 200$ and began to increase strongly again in 2010. Other grain prices too exceeded their peak level from 2008 already in 2011, which had a disastrous effect on the population in many countries.
What are the reasons for the volatility and the increase of commodity prices? The study on Price Formation in Financialized Commodity Markets carried out by UNCTAD on behalf of the AK identifies several causes. Firstly, the demand has risen faster than the supply. Secondly, the greater significance of the financial sector in raw material and commodity derivative markets leads to the fact that price volatility increases and prices no longer reflect actual developments.
Financialization of raw material markets and price bubbles
On the one hand, the reasons for the high volatility lie in the low transparency of the financial markets, but also in the low transparency of demand and supply. On the other hand the financialisation of the markets, hence the systematic expansion of the financial sector, and the herd behaviour of the market participants contribute to the high level of volatility, said Ke Tang of the Renmin University of China. "The total derivatives on the Chicago Merchandise Exchange is 46 times the world production of wheat and 24 times the production of maize. What can justify all this?" revealed Nikolas Sarkozy. Market participants also base their decisions on factors, which have nothing to do with the respective commodity, the fundamentals, but on factors as portfolio considerations or trends on the financial markets, establishes the study by UNCTAD. There is a great uncertainty in the market and many decisions are taken as a result of the behaviour of other market participants (intentional herding). Estimates have shown that currently speculation is responsible for 20 percent of the oil price. Apart from that, the correlation between foreign exchange markets and raw material markets has increased. Other financial markets are gaining influence on the raw material markets. “After 2003, more and more institutional investors have identified raw material markets as new investment markets. Sharks from other markets are taking over. They bring extra volatility,” said Ke Tang. Because of the increasing financial power of various funds, this could trigger a rise and fall of prices.
What now?
It is urgently required to introduce measures, which counteract the increase in speculation and price volatility. Mitchell Hooke, CEO of the Minerals Council of Australia reminded listeners: “I agree with the comments of Mario Draghi [Head of the Italian Central Bank]. The risks are now the same contagious risks as before the crisis.”
Information on production, stock levels and demand would contribute to the transparency of the markets and reduce uncertainty. Apart from that, more transparency is needed at the stock markets and in respect of off-exchange transactions: who are the market participants and which positions do they hold? Stricter regulations as to what may be traded and who may participate in the markets is also a central issue for a better functioning of the markets. As are quantitative position limits. Beyond this kind of ‘soft regulation’, a number of direct commodity price stabilization measures should be considered, concludes the study by UNCTAD, such as the establishment of a government-administered virtual reserve mechanism and the possibility of allowing governments’ direct interventions in the physical and the financial markets. Apart from that the introduction of a transaction tax system could generally slow down the activities of financial investors in commodity markets.
Further information:
UNCTAD Study: Price Formation in Financialized Commodity Markets: The Role of Information
Summary: Price Formation in Financialized Commodity Markets: The Role of Information (German only)
Since the beginning of this century we have seen the price for crude oil rising from 20$ to over 140$ in 2008; then it plummeted to 40$ per barrel within a period of only six months. “Yes, there was less demand and more supply; but this can’t happen within six months. You can't tell me that this is a perfectly functioning market”, countered French President Nicolas Sarkozy some discussion participants at the Conference, such as David Peniket. The President of ICE Futures Europe (one of the largest energy futures and options exchanges) said that the price development and the rising volatility of the prices would not be the result of speculation, but the development of demand and supply. “Future markets and OTC markets play an important role in price identification”.
Over the past years, not only the oil price has been more and more volatile but also food prices. In 2008, the price per ton of wheat rose to 450$ (from previously 200$), fell then back to below 200$ and began to increase strongly again in 2010. Other grain prices too exceeded their peak level from 2008 already in 2011, which had a disastrous effect on the population in many countries.
What are the reasons for the volatility and the increase of commodity prices? The study on Price Formation in Financialized Commodity Markets carried out by UNCTAD on behalf of the AK identifies several causes. Firstly, the demand has risen faster than the supply. Secondly, the greater significance of the financial sector in raw material and commodity derivative markets leads to the fact that price volatility increases and prices no longer reflect actual developments.
Financialization of raw material markets and price bubbles
On the one hand, the reasons for the high volatility lie in the low transparency of the financial markets, but also in the low transparency of demand and supply. On the other hand the financialisation of the markets, hence the systematic expansion of the financial sector, and the herd behaviour of the market participants contribute to the high level of volatility, said Ke Tang of the Renmin University of China. "The total derivatives on the Chicago Merchandise Exchange is 46 times the world production of wheat and 24 times the production of maize. What can justify all this?" revealed Nikolas Sarkozy. Market participants also base their decisions on factors, which have nothing to do with the respective commodity, the fundamentals, but on factors as portfolio considerations or trends on the financial markets, establishes the study by UNCTAD. There is a great uncertainty in the market and many decisions are taken as a result of the behaviour of other market participants (intentional herding). Estimates have shown that currently speculation is responsible for 20 percent of the oil price. Apart from that, the correlation between foreign exchange markets and raw material markets has increased. Other financial markets are gaining influence on the raw material markets. “After 2003, more and more institutional investors have identified raw material markets as new investment markets. Sharks from other markets are taking over. They bring extra volatility,” said Ke Tang. Because of the increasing financial power of various funds, this could trigger a rise and fall of prices.
What now?
It is urgently required to introduce measures, which counteract the increase in speculation and price volatility. Mitchell Hooke, CEO of the Minerals Council of Australia reminded listeners: “I agree with the comments of Mario Draghi [Head of the Italian Central Bank]. The risks are now the same contagious risks as before the crisis.”
Information on production, stock levels and demand would contribute to the transparency of the markets and reduce uncertainty. Apart from that, more transparency is needed at the stock markets and in respect of off-exchange transactions: who are the market participants and which positions do they hold? Stricter regulations as to what may be traded and who may participate in the markets is also a central issue for a better functioning of the markets. As are quantitative position limits. Beyond this kind of ‘soft regulation’, a number of direct commodity price stabilization measures should be considered, concludes the study by UNCTAD, such as the establishment of a government-administered virtual reserve mechanism and the possibility of allowing governments’ direct interventions in the physical and the financial markets. Apart from that the introduction of a transaction tax system could generally slow down the activities of financial investors in commodity markets.
Further information:
UNCTAD Study: Price Formation in Financialized Commodity Markets: The Role of Information
Summary: Price Formation in Financialized Commodity Markets: The Role of Information (German only)