The surge in world commodity prices since last August – an explanation for the layman

Principal reason is a a growth in global industrial production has been maintained at levels well above long term trends, which has tightened the underlying supply/demand balance in the markets.

  • In simple terms this is seen by increased demand in rapidly growing BRIC countries (Brazil, Russia, India, China) and other fast developing regions.
  • This is matched by a relative stagnation in ‘supply’ – crop yields are not rising anything like fast enough to meet shooting demand
  • Now the loss of oil supplies (Libya) has fuelled  this unease still further 

The beginning of a pattern of climatic incidents suggesting that global warming is having at least starting to have a major effect on regions of the world that are traditionally seen as the breadbaskets for food & vital commodities – acute droughts in north eastern China & in Russia in 2010; floods in Queensland and droughts in Western Australia and a similar story in places such as Argentina, the USA and Canada

  • As there is little or no excess margin in terms of ‘supply’ that can absorb this shock in a seamless fashion, price equilibrium is at risk as each bit of poor news fuels market uncertainty still further
  • This is made worse as, unlike oil, there is little or no concrete and reliable information on ‘physical commodity stockpiles,’ there was not a single real calculation when Russia banned grain exports after a damaging drought in 2010, so the market reacts to what little it knows
  • This lack of clarity is compounded by the weakness of bodies monitoring the financial instruments known as ‘standardised commodity derivatives’  – the European Market Standards Authority having a staff of less than 100 to monitor trades across 27 countries & the incoming US Republicans cutting the budgets of the US Commodity Futures Trading Commission still further

The final, and “speculative” explanation is that the US Federal Reserve’s decision to expand liquidity (quantitative easing) has leaked into all risk assets,  including commodities, via financial market demand for these assets. If this is true, it implies that the Fed has imparted an adverse supply side shock into the world economy by raising the oil price due to a lower dollar rate (which ought to have some fairly profound implications for the future conduct of monetary policy around the world).

What’s this mean in simple terms – oil, wheat, corn is traded in dollars – a weak dollar means it is more expensive….with the debt celing hit in the USA in terms of the Federal Budget it is in all our interests that the U.S. deficit is addressed and some strength returns to the dollar.

Why this post? – Well Media Focus has been doing some work in this field and we thought it good to share some of what we’ve learnt…we’ve built some interesting reports for clients – looking at Influencer Network Analysis and then taking the findings through to their conclusions (see above).

How does this affect things moving forward? – This problem is not going away any time soon. The fragility of the balance between supply and demand is so delicate at the moment that a crop plague (one moving across the world right now, charmingly called Ug99) or a wider drought or an exceptionally bad winter or a spread of the tension from Libya to other oil rich nations – and boom – we all fall over the edge

What can we do – pray our politicians get it right as they seek to introduce curbs on the untrammelled speculation that is thriving in the commodity trading markets.  Hope for tighter regulation on that trade and for it to emerge sooner rather than later

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