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World Commodity Trends and Prospects
Ladies and Gentlemen,
It is both an honour and a pleasure for me to address you to present to you UNCTAD´s report on the latest world commodity trends and prospects.
As you are aware, the last decade has seen some fundamental changes to the traditional commodities problematique, which has catapulted the issue of commodities back to the forefront of development policy debates. From the 1960s, up until the early 1990s, commodities prices tended to exhibit two key characteristics, namely a high degree of volatility, as well as a stagnant or downward long-term trend. Indeed, much attention was devoted to helping developing countries cope with both the volatility, and falling price trends. Today, however, the picture has changed in two important respects: Volatility has increased in amplitude (and I will address the reasons for this), and the overall price trend is now positive and looks set to remain so, at least for the next few years, largely due to fast growing global demand. These new trends have brought new worries in their wake. If before we were concerned about the export prospects of commodity-dependent developing countries, today we are designing mechanisms to alleviate food crises and related social unrest, particularly in food importing countries.
This last decade has demonstrated both of these trends very clearly. Commodity prices have displayed very high volatility. The commodity price boom between 2002 and 2008 was the most pronounced of the post-World War II period while the price decline following the eruption of the current global crisis in mid-2008 was notable both for its sharpness and for the number of commodities affected. However, since mid-2009, and especially since the summer of 2010, global commodity prices have been rising again, reaching a new peak in the first half of 2011, before starting to decline again more recently due to increasing worries about the prospects for the world economy. For some commodities, the price peaks of early 2011 exceeded those of the 2008 crisis.
Such commodity price variations impact all countries. However, developing economies tend to be affected most because commodities make up a much larger share both of their trade accounts and their average consumption baskets. Moreover, food and energy prices have a comparatively larger impact on the purchasing power of poor households.
Commodity price developments have traditionally been discussed in terms of changes in fundamental supply and demand relationships. The recent commodity price movements have indeed coincided with major, and well-documented, shifts in market fundamentals. However, there is increasing support for the view that the recent price movements have also been influenced by the growing participation of financial investors in commodity trading for purely financial motives - a phenomenon often referred to as the "financialization of commodity trading".
It is difficult to quantify the relative price impact of fundamental versus financial factors. This is not only because of a lack of comprehensive and disaggregated data on the participation of financial investors, but also because fundamental and financial factors are likely to influence each other. For example, it may well be that a major supply shock signals imminent price increases, which in turn will attract financial investors searching for yield, and thus amplify the price hike. But price changes on financial markets or signals from automated trading may also prompt financial investors to adjust their commodity portfolios, which may be misinterpreted by producers and consumers as signalling fundamental changes. This may cause them to adjust their activities and reinforce price movements.
Recent price developments
Let me, first, focus my remarks on price developments and shifts in fundamental supply-demand balances before turning to financial investors. I will conclude by outlining policy implications.
(a) Agricultural commodities
The UNCTAD agricultural commodity price index peaked in February 2011. However, this aggregate index masks uneven price developments in sub-groups and individual agricultural commodities, reflecting different fundamental factors for each commodity.
The UNCTAD food price index decreased during the first half of 2010 before rising by 20-25 percent and peaking in February 2011. Indeed, food price inflation in developing countries reached 9% in that month. Prices of cereals, vegetable oils and meat increased most. Contrary to the 2008-food crisis, this price increase was less serious for most of Africa, because of good maize and sorghum harvests, but in the Horn of Africa severe drought has exacerbated food insecurity. Asia has experienced high domestic prices for edible oil and some cereals (e.g. wheat). The benchmark wheat price rose to a high of $360 per tonne in May 2011, just short of the $364 per tonne reached in February 2011, but has since receded to $336 in August 2011.
Rice prices rose from $528 per tonne in January 2011 to $574 per tonne in August 2011. Current maize prices - $311 per tonne in August 2011 - are exceeding their 2008-levels. Sugar prices have been on a rollercoaster: they increased by 95 per cent between May 2010 and January 2011, lost more than half of this increase in May 2011, before recovering to 28 cents per pound in August 2011. The vegetable oilseeds and oil price index peaked in February 2011, before declining (by about 7 per cent) in May 2011.
The tropical beverages price index has risen steadily since December 2010, from 243 to 276 in August 2011. The International Coffee Organization composite indicator price index averaged US cents 200.7 per pound from January to August 2011, up 71.6 ¢/lb from the same period in 2010. Cocoa prices peaked at $1.57/lb in February 2011 due largely to supply deficits. However, prices dipped to a six-month low of $1.39/lb in August 2011. Most African producers have enjoyed good harvests in the current crop year due to good weather conditions. For example, cocoa arrivals in Côte d´Ivoire as of June 2011 were 1.286 million tonnes, 22 per cent higher than during the same period in the previous season.
The price index of agricultural raw materials experienced a sharp increase supported by supply shortfalls due to adverse weather conditions and strong demand in Asia. The average of this index for January to August 2011 was 305 and increased by 95 points above the average for the same period in 2010, driven by continuously high prices for natural rubber and for cotton, which reached a historic peak in March 2011 of $2.3 per lb., up 63 per cent from the 2009 average.
Thus, while we have seen a generally positive trend with the global recovery until the first half of this year, followed by a decline more recently, the exact pattern differs by commodity.
(b) Minerals, ores and metals
Let me now turn to minerals, ores and metals. UNCTAD´s monthly minerals, ores and metals price index increased by over 20 per cent between January 2010 and August 2011, driven by tin, nickel and copper rises, including because of tightening supply combined with continuous strong demand from Asian economies and Brazil. Over the next few years, rising costs, declining ore grades and an insufficient opening of new mines is likely to cause supply growth to continue falling short of demand growth. As a result, metals prices could rise further in the medium term.
Similarly, we are seeing upward trends for copper and lead. In 2011, growth in global copper demand is expected to outstrip copper production. Uncertainty resulting from factors such as changes in trade and monetary policies and the fallout of the Tohoku earthquake in Japan could increase production deficits and influence prices. Lead, zinc, nickel and tin prices fell in 2008, recovered in 2009 and trended upward trend in 2010, including because of the fast pace of growth in Chinese refined output.
Gold has traditionally been considered a safe haven during times of uncertainty. Since the onset of the financial crisis, gold prices have increased sharply and, in August 2011, the monthly average gold price saw a new record of $1,756 per ounce as investors took refuge following renewed economic turmoil in both the United States and Europe, and in particular the continuing sovereign debt problems in the Euro zone periphery.
The Financialization of Commodity Markets
Let me now turn to the new phenomenon of the so-called financialization of the commodity-markets, which in our view has played a prominent role in amplifying the boom-and-bust cycles in commodity prices.
While the growing participation of financial actors in commodity markets is generally recognized, but there has been considerable debate as to whether the often large size of financial investments and their underlying position-taking behaviour has raised the level and volatility of commodity prices. Indeed, it has to be acknowledged that greater participation by financial investors in commodity futures markets also has the potential to bring economic benefits by making markets deeper and helping to accommodate the hedging needs of commercial users. Financial investors can also promote the liquidity of markets for longer-term futures contracts, facilitating risk management and long-term planning of commodity producers and consumers.
However, the greater participation of financial investors is likely to have caused commodity markets to follow a more speculative logic where herd behaviour often dominates. Herding in commodity markets can be irrational, based on what may be called "pseudo-signals" such as information related to other asset markets and the use of inflexible trading strategies, including momentum investment or positive feedback strategies. Such strategies assume that price developments of the past carry information on future price movements, giving rise, for example to trend chasing. This results in buying after prices rise and selling after prices fall, independently of any changes in fundamentals.
More worryingly, herd behaviour can also be quite rational. Information-based herding, for example, occurs when traders believe that they can glean information by observing the behaviour of other agents. In other words, investors converge in their behaviour because they substitute collective for individual information signals. Position-taking based only on other peoples´ previous actions will lead to price changes without any new information being introduced to the market. A sequence of such actions can cause a snowball effect, which will eventually lead to self-sustaining asset price bubbles. Informational herding of this kind is most likely to occur in relatively opaque markets, such as in commodity trading.
According to our research, the high correlation between returns on investment in commodities and those on other asset classes indicates that such behaviour has indeed become widespread in commodity markets, thereby increasing the risk of commodity price bubbles. Perhaps most importantly, the fact that some countries have tightened monetary policy in reaction to price pressure stemming from commodity price hikes, which may well be speculative bubbles, indicates a worrisome aspect of financialization that has so far been underestimated, namely its potential to inflict damage on the real economy induced by sending the wrong signals for macroeconomic management.
The financialization and related speculative investments have priced many commodities out of the hands of some of the poorest populations, contributing to higher levels of poverty and malnutrition, as well as social unrest.
Policy measures in response to commodity price instability
It is clear, therefore, that a key challenge for policy-makers is to identify innovative and coherent policies at national, regional and international levels to ensure that price volatility does not impede growth and development, and poverty eradication efforts.
In this regard, it might be useful for the international community to explore the potential of enhanced cooperation between producers and consumers with a view to stabilizing markets. Various income support programmes can also play a role in addressing short-term price shocks and associated income fluctuations.
Market-based risk management instruments, such as futures, options and weather-index insurance, could also mitigate exposure to commodity price volatility and other risks. However, serious efforts are needed to build required institutional mechanisms, including the legal and regulatory framework, and to train potential users of these instruments. Furthermore, tighter regulation and greater transparency are important for reducing excessive price volatility in the "financialized" commodity markets and to ensure the fundamental role of commodity derivatives markets in price discovery and risk transfer.
A set of four policy responses to improve derivatives market functioning should be considered, especially for food and energy commodities:
First, greater transparency in physical markets would enable the provision of more timely and accurate information about commodities, such as spare capacity and global stock holdings for oil, and for agricultural commodities, areas under plantation, expected harvests, stocks and short-term demand forecast. This would allow commercial market participants to more easily assess current and future fundamental supply and demand relationships.
Second, a better flow of and access to information in commodity derivatives markets, especially regarding position-taking by different categories of market participants, would further improve market transparency. In particular, measures designed to ensure reporting requirements for trading on European exchanges similar to those enforced in United States exchanges would considerably improve transparency of trading and discourage regulatory migration.
Third, tighter regulation of financial market participants, such as through establishing position limits, could contain financial investors´ impacts on commodity markets. Proprietary trading by financial institutions that are involved in hedging transactions of their clients could be prohibited because of conflicts of interest. A similar rule could be applied to physical traders, prohibiting them from taking financial positions and betting on outcomes that they are able to influence due to their strong economic position in the physical markets. This calls for finding the right balance between being adopting overly restrictive regulation, which would impair the price discovery and risk transfer functions of commodity exchanges, and overly lax regulation, which equally impairs the basic functions of the exchanges. The recent decision to strengthen regulation of commodities markets by the United States Commodity Futures Trading Commission, as well as similar efforts by the European Commission, are steps in the right direction.
Fourth, market authorities in charge of surveillance could be mandated to intervene directly in exchange trading as necessary by buying or selling derivatives contracts with a view to deflating price bubbles. Such intervention could be considered a measure of last resort to address the occurrence of speculative bubbles if reforms aimed at achieving greater market transparency and tighter market regulation were either not in place or proved ineffective. While most of the trigger mechanism could be rules-based, and therefore predictable, such intervention would necessarily have some judgemental components. While such an agency would have access to the same market information, contrary to the other market participants, it would have no incentive to engage in any form of herd behaviour. Rather, it could break the informational cascades that underlie herd behaviour by announcing when, in its view, prices are far out of line with fundamentals. Hence, as in the case of currency markets - and, recently, the bond markets - it should be possible for market authorities to undertake occasional targeted interventions in asset markets by acting as market maker or as the one institution that is able to shock the market once it becomes evident that it has gone into an overshooting mode.
Ladies and Gentlemen,
Let me conclude, by emphasizing that addressing the financialization of commodities markets and the attendant boom-and-bust cycles will play a crucial role not only in harnessing the benefits of commodities trade for development and poverty reduction, but also in putting the world economy on a more stable growth path, by reducing the impact of disruptive speculative flows.
Thank you very much.