Financialisation of Commodity Markets Flashcards
What are commodity Markets
Commodity markets have become more like financial markets in some respect. ‘A commodity is something that hurst you when you drop it on your big toe, or smells bad if you leave it out in the sun too long’ (Barron 1983)
Why do Commodities Matter
They are a major share of World Trade
29% including fuels (13% excluding)
Most advanced economies are net importers
Less advanced economies depend on exports (50%)
Concern over Prices
Demand is relatively stable
Effects of Shocks - Permanent and temporary
Time period for supply means SR is a long time and elasticity low
- Minerals need new mines
- Coffee bushes need 7 years to mature
Price levels depend on
- Time period considered
- Ex post measurement v. ex ante prediction
- Estimation method - Various forms of GARCH models
Impact of Producers and Consumers
- Rapidly increasing prices and inherent volatility create risk
- Rising prices can fuel inflation in consuming countries
- Export earning uncertainty in producing countries
- Producers face problems due to lack of means of dealing with risk and affects investment.
Commodity Price Spike
Wall of money moved into commodity markets in th elate 1990s & 2000s from financial institutions
Mid 2000s saw global commodity prices rise rapidly
What Caused the Spike
Changes in Customer Demands
- Population Growth in India and China
- Value of the USA dollar: Commodities priced in USD, when USD depreciates, the fundamentals driving the comjmodities prices may remain unchanged. Then if the prices do not adjust, these products will be cheaper, due to weaker USD.
Supply side - Weather Shocks e.g. drought, floods
Supply side - The price of oil and biofuels?
Financial Speculation
Volatility
Standard Deviation of relative price changes
Volatility creates problems for those in the physical trade but also opportunities for those wanting to earn a return on investments .
Financialisation of Commodity Markets
key aspect here is having a route in to commodity markets that allow for investors to generate a return
Use futures markets and that is what has happened
New products allow investment in commodities through long-only index funds, over the counter swap agreements, exchange traded funds, and other structured products.
Dodd-Frank Rule
Increased financial activity drove up commodity prices beyond their real level and this persuaded Senate to pass the Dodd-Frank Wall Street Reform Act (2010) which restricts the ways banks can invest, limiting speculation trading and eliminating proprietary trading
What are the markets speculators operate in?
Futures markets
- Developed in Amsterdam in 1600
- Moved to New York/Chicago/London
- All commodity based
Recent growth is in financial futures or derivatives
Recent growth in futures markets
Range of contracts
Sophistication of contracts
Exchanges
Differences in Futures and Options market
Futures contracts have the buyer obligated to honour the contract, whereas in options contract, there is no obligation on the buyer to buy or sell
Futures require a higher margin of payment as compared to options
Futures contracts are preferred by speculators, where as option contracts are preferred by hedgers
