UN report: Governments need to burst the commodity bubble

As I am in Vancouver today speaking at the largest commodity investment conference in North America, a new UN report highlighting the unhealthy rise in commodity prices caused by “investors” and unregulated speculation is very much on topic for my presentations. The UK Guardian reports:

“Government intervention may be needed to burst the huge bubble that has developed in the price of commodities such as food staples and oil, a UN report says .

Prices have rocketed in response to dysfunctional commodities markets, according to the report, which also disputes the view of many senior economists and central bankers that commodity prices have jumped as a result of a surge in demand.

“The changing role of commodity markets, which are turning into financial markets, has enormous repercussions for the economy,” said one of the report’s authors – Heiner Flassbeck, a director at the UN conference on trade and development (Unctad).

“The possibility of allowing governments’ direct intervention in the physical and financial markets needs to be considered,” the study concluded.

Investors are encouraged to behave like a herd, says the report, with few incentives to arbitrage or bet against the tide of rising prices. Without checks and balances in the system, investors create price bubbles that put many basic foodstuffs out of the reach of millions in the developing world.

Oil may be as much as 20% over valued while maize, the staple food of many developing world economies, is subject to wild swings in price…

“If the efficient market hypothesis were to apply, commodity price developments would reflect nothing but information on fundamentals. However, this study shows that the hypothesis does not apply to the present commodity futures markets,” the report says.

“Another major factor is the financialisation of commodity markets, which has played a significant role in price developments in recent years,” the report says. Its importance increased steadily after 2004, as reflected in rising volumes in commodity derivatives markets – both at exchanges and over the counter (OTC). “This phenomenon is a serious concern, because the activities of financial participants tend to drive commodity prices away from the levels justified by market fundamentals, with negative effects on producers and consumers.”

The whole article is worth a careful read here and underlines the large downside risk now present for commodity-centric countries like Canada where the inevitable correction in prices needed to reconnect with demand reality will hit our stock market, currency and economy with particular force. This downside risk is not likely to be reflected in our government’s new budget being presented today.

The reining in of commodity speculation will also hit investment banks who have been milking the commodities frenzy hard the past few quarters with a 55% jump in revenue coming from their commodity based products. No wonder the US government has been reluctant to enforce proper controls against their banker buds. See WSJ: Big banks cash in on commodities.

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