we Heading for Another Global Primary Commodity Price
13th 2010, C.P. Chandrasekhar and Jayati Ghosh
before the financial crisis broke out so violently in
the US and caused ripple effects all over the world,
most people in developing countries were already reeling
under the effects of dramatic volatility in global food
and fuel markets. In 2007 and 2008 prices of most primary
commodities first increased very rapidly, to a degree
that was completely unwarranted by actual changes in
global demand and supply. Then they collapsed, from
peaks in May-June 2008, at even more rapid rates than
their previous increases. But in many countries the
fall in global prices was not associated with a fall
in prices paid by consumers, while the actual producers
(such as farmers) rarely benefited from the price increases.
It is now quite widely accepted that financial activity
- specifically the involvement of index investors -
was strongly associated with these dramatic price movements.
Commodities emerged as an attractive alternate investment
avenue for financial investors from around 2006, when
the US housing market showed the initial signs of its
ultimate collapse. This was aided by financial deregulation
that allowed purely financial agents to enter such markets
without requirements of holding physical commodities.
This generated a bubble, beginning in futures markets
that transmitted to spot markets as well.
Thereafter - even before the collapse of Lehman Brothers
signalled the global financial crisis - commodity prices
started falling as such index investors started to withdraw.
The global recession that was evident from mid 2008
led to perceptions that commodity prices would not firm
up any time soon. While this contributed to fears of
deflation in the context of liquidity trap conditions,
this was even seen to be an advantage especially for
food and fuel importing developing countries, whose
import bills would be reduced accordingly.
But while the collapse in commodity prices after the
recent peak was sharp, it proved to be quite short-lived.
Most important commodity prices - especially food and
oil prices - have been rising from early 2009, even
before there was any real evidence of global ''recovery''.
1 shows that global food prices, which nearly doubled
between June 2007 and June 2008, fell very sharply thereafter
and were back to the June 2007 level by December 2008.
But thereafter they have been rising once again, such
that the increase between December 2008 and November
2009 has been more than 16 per cent on average across
all food commodities. Agricultural raw materials prices
did not rise as quickly and fell more in the second
half of 2008, so their recent price increase has been
sharper, close to 35 per cent in the seven months between
May and November 2009. But this means that they are
on average only just back to the level of two years
Other non-agricultural primary commodities - metals
and other industrial inputs, showed less price increases
during the 2007 commodity boom, more volatility over
the course of 2008 and sharper falls thereafter, so
that by the beginning of 2009 their prices were below
those of January 2006 (Chart 2). But these prices have
exhibited particularly pointed recovery since then,
increasing by more than 50 per cent in the case of metals
between March and November 2009, and by 43 per cent
in the case of other industrial raw materials
Of course energy prices are particularly crucial, and
here the recent trend in both all fuel prices (including
coal) and only petroleum prices, has been quite marked
as well. Chart 3 shows a picture of great volatility,
but the extraordinary price increases of 2007 to mid
2008 and the subsequent fall tend to reduce the attention
to more recent trends. Thus, in the eleven months of
2009 for which the data are now available, fuel prices
have increased by 53 per cent and oil prices have increased
by 88 per cent. In any other period such increases would
be the object of widespread attention and the subject
of endless commentary. But because we live in such ''interesting
times'', with a recent history of even greater and more
rapid increase and decrease, they have largely gone
Why is this happening? And what does it portend for
the future? It was noted earlier that the recovery in
most primary commodity prices actually predated the
global output recovery. As was the case in the previous
price surge of 2007-08, these recent price increases
are unlikely to be related to any real economy changes
in demand and supply. Despite some supply shocks in
particular crops, according to the FAO most agricultural
goods in 2009 showed approximately the same demand-supply
relationships that existed in the previous years, with
no force making for any significnt upward or downward
price trend. So if prices are increasing, it must be
because of the effect of expectations combined with
heightened speculative activity in commodity markets,
especially in commodity futures.
Indeed, there is no reason for such speculation to be
curbed at present; if anything, the low interest rates
that are being maintained by most major economies as
part of the recovery package, combined with the immense
moral hazard generated by the large financial bailouts,
are likely to have made the appetite for risky behaviour
much larger. Both gold and other primary commodities
are once again emerging as prime areas of interest for
financial institutions, and some of the large (and succcessful)
financial players such as Goldman Sachs are expanding
or opening new commodity investment sections.
4 >> Chart
As Charts 4 and 5 indicate, the value of OTC (over the
counter) futures contracts in both gold and other commodities
has tended to track spot price movements. Since OTC
contracts do not occur in regulated exchanges (and in
any case effective regulation that would constrain speculative
activity in commodity futures is not yet in place in
any of the major financial centres) such activity still
has the potential to cause wild swings in commodity
prices that are not justified by any fundamentals.
This creates a piquant situation for economic policy.
In macroeconomic terms, the global threat of deflation
is still greater than that of inflation, especially
because the financial crisis is far from resolved or
even properly dealt with and is bound to result in new
problems in real economies sooner rather than later.
However, both the nature of the recent recovery and
the policy response to the crisis (which has provided
more liquidity without adequate control or regulation)
suggest that primary commodities may well witness a
price surge once again.
Such price surges have huge negative implications for
developing countries. Because they are the result of
financial activity, they typically do not benefit the
direct producers who may be resident in the developing
world. But they cause huge damage to consumers of food
and other essential items, typically the poor in developing
countries who are the worst affected as the prices of
necessities increase even as their employment and wages
continue to languish.
If these very adverse effects are to be avoided, financial
regulation to curb speculative activity in commodity
markets must become an urgent priority at both national
and international levels. The governments of large developing
countries that are now beginning to flex their muscles
at various international fora would to well to recognise
the critical urgency of such measures, if they really
want to benefit their own people in international negotiations.