“The financialization of commodities has been the dominant factor“ (John Baffes)

A conversation with John Baffes from World Bank

The spot price of Brent and WTI crude just passed this week $80 per oil barrel, the open price of the first trading day of 2010. In April the average Brent price was above $89. The price average for the seven first months of 2010 is $9 above the 2009 average, up 12 percent.

Speculators also rediscovered some agricultural commodities and metals. Some futures contracts just rallied. Sugar had its historical peak at January this year and coffee at July. Cotton price yearly change is above 41 per cent, silver and platinum above 30 per cent and copper above 29 per cent. Wheat, cocoa and soybeans futures contracts are also in an uptrend, although below the peaks at 2009 and 2008. Wheat, copper and sugar are the commodities with the largest monthly percentage change so far.

For instance regarding wheat, worries over the drought in Russia and heavy rains affecting planting in Canada – two world’s largest grain producers and exporters –  propelled European wheat prices to a two-year high of €211 per ton on August 2, almost a 50% increase since late June. Although, there are some indications that hedge funds covering short positions after the initial price rise might have exacerbated the situation, thus further pushing up prices.

Russia temporary ban on wheat, corn, barley, rye and grain exports until the end of this year and premier Vladimir Putin political pressure upon Kazhakstan and Belarus to impose similar bans fuelled fears of agroflation and higher speculative spikes by non-commercial investors in the commodity markets.

Investment funds and money managers now include commodities as targets for their portfolios, so important as stocks, bonds, swaps or real estate. Some food prices are climbing again as hedge funds for instance found they can amass gross profits purchasing futures’ contracts of tons of those commodities. But, in reality, only a small part of these futures contracts end with a real exchange of goods. Sometimes the annual volume of trading is 10 or 20 times the volume that is physically available. The “gap” is pure financial speculation.

The FAO food price index jumped to 163 points in last June, only 28 points below the peak in 2008.

Thus the goal is to find which factors behind this recent boom have a historical track record and likely will remain in place.

Starting in the mid-2000s the prices of the trilogy of commodities (food, energy and metals) reversed the downward trend of the previous 20 or so years leading to a price boom. Between 2003 and 2008 nominal prices of energy and metals increased by 230 percent. Those of food and precious metals doubled. Those of fertilizers increased fourfold.

The price drunkenness of Summer 2008

The price drunkenness reached the peak in July 2008 (before the financial panic), when crude oil spot prices (day closing prices) peaked at $145.29 for a barrel of WTI in the US, and $145.91 for the Brent barrel in Europe. Also, rice prices doubled within five months of 2008, peaking in April. Cocoa, corn and soybeans peaked in June the same year.

Gold, the king of precious metals, jumped from $250 to $1200 per ounce in only a decade. The yearly change so far in 2010 is 27 per cent. Why this consistent uptrend? Two main reasons: financial diversification in “paper” gold; emerging countries’ strategies in actual (physical) gold and particularly the demand pressure from China. This week, China said it will let more banks import and export gold, the government’s clearest signal that it plans to increase the country’s presence in the global gold market, including overseas investments. China is the world’s biggest producer and it’s the second world consumer of gold. The country has increased gold imports in recent years as the People’s Bank of China (the central bank) has boosted gold reserves and as domestic interest in gold investment has grown.

Lots of structural, political or geoeconomic reasons have been argued on the media and at academic conferences for this unusual nominal prices spike: peak oil for crude; the rising of emerging economies (particularly China) and its voracious appetite for everything that smelts to commodities; and biofuel political strategies in the case of food commodities.

“New” factors came to town

John Baffes, senior economist from the Development Prospects Group, at The World Bank, in Washington, United States, with Tassos Haniotis, Head of the Agricultural Trade Policy Analysis, Directorate General for Agriculture, of the European Commission, just published a paper with a summary of their research (“Placing the 2006 () 2008 commodity price boom into perspective”, Policy Research Working Paper 5371, 2010) putting the recent commodity price boom into perspective.

They found the price boom was fueled by various factors, not only the “traditional” ones (demand pressure, climate change impact, dietary changes, mass population dislocations from rural to urban spaces, supply shocks, interest rates manipulation, geopolitical events and concerns), but also “new” ones like the financialization of commodities by the financial institutions and the diversion of some food commodities to biofuel production.

Baffes and Haniotis found that financial diversification may have a permanent character; speculation comes to commodity town to stay. On the other end, they doubt about claims that biofuels account for a big shift in global demand. “Biofuels played some role, but much less than initially thought,” they wrote at the concluding remarks.

Their econometric analysis bring another two important conclusions about the long-term evolution of commodity prices: a) we can observe a strange ecosystem of co-movements and synchronization among the prices of the three main groups of commodities; this means we cannot analyze commodity markets in isolation from one another; b) price variability, sometimes with wild oscillations, overwhelms price trends.

The synchronization of the three groups is a first in economic history. The profile was different during the oil shocks period of the 1970s and 1980s and during the Korean War in the beginning of the 1950s.

Forecasting is now a difficult task. Policy making as well. Commodity markets nowadays do not behave as “planned.”

Janelanaweb.com interviewed John Baffes, just beginning a mission in Indonesia.


#“The financilization of commodities is, perhaps, the only “new” factor among the many factors responsible for the price boom (perhaps, one can add biofuels here).”

#“To summarize, all evidence points to the fact that commodities have entered a period of higher price variability. “

#“As income in developing and emerging countries grows, we will see a synchronization among the prices of all resource-based commodities.”

FAST INTERVIEW by Jorge Nascimento Rodrigues

Q: The financialization of commodities is the dominant aspect of this period of Recession, more than the demand growth from the emerging countries or the so-called peak oil trend?

A: Among the many factors that have affected commodity prices, perhaps the financialization of commodities has been the dominant one. That is not to say that financialization will affect the overall trends. Trends will be affected by supply and demand conditions, especially technology and income levels. However, the fact that commodities have been used as financial instruments, it is going to affect a lot of price variability, as it most likely did during the course of the 2007/08 boom. It is also important to have in mind that financialization of commodities is, perhaps, the only “new” factor among the many factors responsible for the price boom (perhaps, one can add biofuels here). The remaining of the factors, such as income growth, $US depreciation, low interest rates, low investment, etc. have been with us other time as well.

Q:  After 30 years of “great moderation” in the variance of prices, we entered a period of wild oscillations? Oscillations overwhelms eventual price long trends?

A: Oscillations have traditionally overwhelmed trends (in most cases). For example, although agricultural commodities have been following a downward trend for more than a century, high variability on certain periods is so large that the trend (estimated at about 1.5% per year) is pretty much irrelevant. There are two factors that are likely to play key roles. First, for agriculture, we have changing weather patterns. If, indeed, weather patterns are changing, as many fear, then we are likely to see large changes in production patterns and hence large price variability. And, as mentioned above, if investment fund managers believe that commodities are assets that should be held in their portfolio in the long term than we may see additional variability coming from that side as well. To summarize, all evidence points to the fact that commodities have entered a period of higher price variability.

Q: Commodities – food, energy, metals – now form a kind of ecosystem with hard co-movements and synchronization?

A: This is one of the key points of our paper (and other research as well). There are three links between energy and agriculture: (i) commodities are energy intensive and high energy prices means high food prices; (ii) some food commodities go for energy (through biofuels); (iii) agricultural commodities are using fertilizer, which itself is highly correlated with energy (some fertilizers are made from gas). Therefore, we expect to see greater co-movement between energy and agriculture. Furthermore, as income in developing and emerging countries grows, we will see a synchronization among the prices of all resource-based commodities (i.e., energy and metals).

One Response to ““The financialization of commodities has been the dominant factor“ (John Baffes)”

  1. Very well researched and written. My understanding is that the same ‘families’ control commodities, agriculture, and everything else for that matter and that all markets are manipulated in their favour. In turn leaving them with more control (power) and the rest of us in greater poverty.

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