Commodity Prices: Supply, Demand and Speculation

For awhile, commodity prices starting to climb again, which some, like me, took as a sign that the economy would soon start growing again. I heard a rumor that editor of the Journal of Environmental Economics and Management predicted oil will hit $100/bbl by the end of the year. But now commodity prices are falling off again.

I think Paul Krugman's tidbit on all this is right on the money: it's been speculation about "green shoots" that now are not materializing as expected. Unlike the much larger boom in commodity prices that culminated in last summer's record peak, the recent more modest rise appears to be due to speculation. This is indicated by the rise in inventories that accompanied the boom. The market was anticipating world demand to rise as the recession bottomed out and growth resumed. So, instead of selling commodities at low prices, commodities were stored, in speculation of higher future prices. But future demand growth is proving more elusive than thought, so prices are falling off again, a lot like long-term interest rates.

Looking more broadly at the pattern commodity prices, something quite astonishing has happened over the last few years. Price fluctuations have become much more a demand-related phenomenon than a supply-related phenomenon.

For energy price fluctuations used to come mainly from oil embargoes, wars, and worry about impending wars or other events creating supply interruptions. Occasionally there was worry about OPEC commitments having real teeth. Thus, there were supply actual shocks or speculation about possible supply shocks that sent prices soaring, with prices falling once the actual or feared shock abated.

For agricultural commodities prices trended down due to remarkable yield growth. Price fluctuations came mainly from surprises in the weather. Prices and inventories would occasionally build up because markets anticipated some kind of supply disruption.

But today it's all about demand. Demand for all kinds of commodities from oil to food grains came from tremendous growth in China and India. Supply growth couldn't keep up. Agricultural commodities got an additional demand boost from ethanol, which also linked agricultural prices more closely to energy prices. Then, when the global economy tanked, so did commodity prices. And today speculation, instead of being about possible supply disruptions, is all about when demand growth will resume.

Killian has a nice technical academic paper on all of this, focusing on oil prices, recently published in the flagship economics journal (AER). Here's an unguarded version. It's also pretty obvious if you just stare at the data long enough. The story looks very similar for agricultural commodities.


  1. Thanks for the thought-provoking post!! Here are my thoughts (from my blog post in response):

    I agree on oil - demand certainly has tanked due to the recession. I am not so sure on ag. First, the 2007/8 run-up in world cereal prices was caused by a complex set of factors including some on the supply side, like droughts in Australia and rice export bans in Vietnam, India and Egypt. Second, food demand is not as elastic as oil demand - people for the most part keep eating in a recession (not to insensitively downplay unfortunate exceptions), and the RFS mandates which drive the majority of corn ethanol and biodiesel demand remained in place. Third, unlike oil (where supply proved fairly inelastic in the face of record prices), high food prices provoked an impressive supply response - according to The Economist, "farmers harvested 2.3 billion tonnes of cereals in 2008/09, the biggest crop ever seen."

    In conclusion, while in oil a peak supply/Peak Oil dynamic may be in play, I don't think we are at Peak Ag yet (although the more one looks at water, soil degradation and climate change, the more one worries it may be closer than most people think). In the medium term, both supply and demand in ag are flexible and speculation will continue to be about both, and at what price they'll meet to clear the world market.


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