MPDD Seminar Series on
What role for speculators in driving commodity prices?
Margit Molnar and Yusuke Tateno
Macroeconomic Policy and Development Division, UNESCAP
Thursday, 5 April 2012
MPDD Meeting Room
7th Floor Block B, Secretariat Building
Commodity price booms have not always been fully explained by underlying economic fundamentals, in particular in some of the recent experiences physical demand appeared to have little role in driving commodity prices. This suggests that there may be other factors driving the price surges such as supply-side disruptions (in production), export restraints or financial investors. Another view is that the commodity price surge has been so broad based including agricultural and other commodities without organized futures markets, that speculation could not possible have driven it.
Undoubtedly, physical demand has not been the sole driver of price surges, the question is to what extent other factors contributed. Geopolitical factors have played a role, for instance in disruptions of oil production in the Middle East (e.g. Libya) exerting an upward pressure on prices. Several measures have, however, been adopted to counter such effects including increasing capacity utilisation in other producers (i.e. Saudi Arabia) and recently the release of oil reserves by OECD members to the market on the recommendation of the International Energy Agency (IEA). Export restraints in the form of export quotas are seen to have contributed to the several-fold rise in the prices of some minerals, such as rare earth metals and export bans on agricultural commodities to the food price surges.
The financialisation of the commodities markets accelerated when the subprime crisis made investors disappointed of complex asset backed securities, inducing a kind of flight to simplicity. With reduced risk appetite, other asset markets such as stock markets also experienced an exodus of funds in favour of commodity markets. Monetary easing has also contributed to the surge in commodity prices as at lower interest rates producers have less incentives to increase production so that the proceeds can be invested in high-yielding instruments.
The literature on the determinants of commodity price surges has been inconclusive as to whether speculation is the driver behind. The lack of ambiguity of findings of the literature related to the determinants of commodity price rises stems from various sources including the econometric method used, the specification of the model (in particular omitted variables), the choice of data to capture the variables of interest, the time period examined, the sample of countries and other factors. The ambiguity of the literature on the effect of speculation on commodity price hikes is partly related to the inadequate or improper capturing of what speculation stands for. By definition, speculators are investors not actually holding commodities but seeking arbitrage opportunities in commodities futures and options markets. This, it includes a diverse selection of actors such as hedge funds, financial institutions, commodity trading advisors, commodity pool operators, associate brokers, introducing brokers, floor brokers and other non-commercial traders.
The present work undertaken at MPDD found that speculators, defined as non-commercial traders, indeed have a role in driving commodity prices. More specifically, in addition to their potential direct impact on commodity prices (short and long-term), they tend to reduce the speed of adjustment towards equilibrium. That is, once the prices are affected by a shock, speculators prevent a rapid return of prices to equilibrium levels. This finding highlights a new role for speculators in commodity markets.
You and your colleagues are cordially invited to attend the seminar and particpate in the discussions.