We noted earlier this week how a recently released United Nations report on price formation in commodity markets had recommended that government take an active role in attempting to manage commodity prices.
We found this disturbing and pointed out how the report acknowledged some of the fundamental factors behind the recent surge in commodity prices but then ignored them in seeking solutions.
The report talks about the surge in demand in emerging and emerged economies. The report also talks about how the use of food based commodities in biofuels has affected price and how government mandates that subsidize that use, have affected price. Oddly the UNCTAD report recommends more government mandates for a problem partially caused by government mandates.
The report also acknowledges the role of a weakening dollar on commodity prices and the fact that commodities have always been seen as a hedge against inflation.
But while acknowledging these real fundamental factors the report suggests that they alone do not explain the price surge and look to the financialization of commodities and the increasing number and impact of speculators. It seems odd to decouple the two because it is these fundamental factors that the speculators are reacting to.
The report’s analysis reminds me of the old philosophical riddle, “If a tree falls in a forest and no one is around to hear it, does it make a sound?"
However we must change the riddle a bit.
If nobody used commodity markets to hedge against inflation and the depreciation of the dollar, would commodities still go up in the face of rising inflation and a falling dollar?
If you follow the UN and the rest of the blame speculators crowd’s logic, the answer is no. They acknowledge that growth in Asian economies is leading to greater demand for meat and the grain to feed cattle and that commodities react inversely to a falling dollar and are used as a hedge against inflation but argue that those obvious fundamentals do not explain in full the rise in commodity prices. For that they blame excessive speculation or the financialization of commodities. However, it is exactly those fundamentals speculators are following. It is why they are speculating that prices will rise.
My favorite line from the executive summary of the report is: “The analysis clearly shows that information flows play a vital role in commodity price developments. The market distortions described above are closely related to the fact that market participants make decisions under conditions of substantial uncertainty (emphasis mine).”
They just described trading.
Futures markets provide certainty for hedgers in that they can lock in the price of a commodity, the future price of which is uncertain. A speculator speculates on the uncertain price of a commodity. Without “substantial uncertainty” there would be no need for these markets. Markets by their nature are substantially uncertain.
Be weary of anyone or any institution that believes they can change that fundamental truth.