Commodity prices and speculation, again

The other week I got a list of questions from a journalist at China's Life Week, which is presumably the country's biggest news magazine.

The journalist asked:
1.     The U.N. Food and Agriculture Organization's index of world food prices rose 32 percent in the second half of 2010, topping the peak of June 2008. In your analysis, what are the major reasons for such a great increase in a short time?
2.       In your analysis, how much does the food speculation influence current high food price?
3.       Money began to be taken out of the index funds in the couple of months before food prices began to fall dramatically in mid-2008. What about the situation in 2010? If the moneys pour into the field again, why?
4.       In the past 2 years after food crisis in 2008, how did the biofuel develop around the world?
5.       In your analysis, how much does biofuel influence current high food price? How?
6.     U.S. government makes great effort to develop biofuel. What are the government’s concerns?
7.    A EU-World Bank analysis of the causes of the 2007-2008 food price crisis blames energy prices and financial speculators for the hikes. Will the same situation happen in 2011? Is there any difference between the situation in 2008 and now?
I was busy at the time and so a bit late in my replies, which were as follows:

1. I think prices are rising mainly in response to increased growth and demand in the Southern Hemisphere and Asia, but particularly from China.

2. Speculation is an important part of commodity prices, but as far as I can tell, only in good ways. For example, if the market expects demand to rise in the future, prices may go up today, since some of today's production will be placed in inventories in anticipation of higher future demand.  Without speculation, we wouldn't have markets trying to maneuver production from times when it is less valued to times when it will be more valued.

Note that speculation does not necessarily imply a speculative bubble.  I do not think there is a speculative bubble in commodities, nor do I think has been one in recent history.  I agree with the likes of Paul Krugman who has pointed out several times, that for there to be a speculative bubble in commodity prices, there needs to be a general buildup in inventories.  We have not seen such a buildup in inventories.  It's been quite the opposite: prices have gone up in response to declines in inventories.  This is what happened in 2008 as well.

3.  I don't think the money coming out of index funds has anything to do with commodity prices.

4 & 5  I think biofuel demand, artificially stimulated by government subsidies, was a big factor in the 2008 rise and one factor keeping prices high today. In my work with Wolfram Schlenker (currently under revision for the American Economic Review) we find the *long run* effect of the biofuel demand on the world's major staple commodity prices is on the order of 20-30 percent.  But in the short run, the spike could have been larger.  It also had the effect of drawing down inventories which made market prices far more susceptible to temporary weather or other kinds of shocks.

6. I think U.S. biofuel policy is misguided, mainly for the reasons outlined in 4&5--these costs to the world, especially the world's poorest, are just too high.  Also, I'm very skeptical that biofuels actually reduce CO2 emissions.  The one benefit I see is that by subsidizing ethanol it may lead to innovation of other biofuels that make more sense.  I hope that happens.  Still, if that is the goal, a better policy would be to directly subsidize research and development, not production of the fuel itself.

7. Energy prices were a big part of the 2008 price spike, mainly due to the ethanol link.  Speculation was not, as described above.  Another big factor was global demand growth, much like it is today.  For most of the last 75 years, growth in crop yields was faster than demand growth.  That's no longer the case.  Demand is growing faster than supply, and so prices are rising.  It's hard to see what will reverse the new trend.

Today Krugman writes about commodity prices and makes some similar points.  But I didn't know about the cotton hoarding in China.  That may or may not be rational speculation--I just don't feel I know enough to venture a guess.


  1. I don't believe the CO2 rationale for biofuels either (at this point, and maybe not going forward). The more coherent rationales are
    (1) that biofuels provide energy storage that has sufficient energy density to be practical for transportation (unlike solar or wind);
    (2) biofuels provide some measure of energy security, a domestic source of transport fuel in case some exigency, say, closed the Suez Canal or something; or
    (3) current generations of biofuels take us on a path with improved biofuels with greater benefits (or different kinds of benefits).

    I don't know if I believe (1) or (2) or whether (3) is important enough to continue. But those are the rationales I would use to evaluate biofuels programs.

  2. If global demand growth is a significant driver in the rise of commodities in recent years I would have thought that we would have seen a similar rise in the price of a broader range of global food commodities; in particular I have in mind meat prices, which have not seen demand rise in any major way, going on the price signal.

    The cheaper meats, like pork, are largely based on corn-soya diets. The rise in inputs cost is putting the intensive industries under intense pressure as the price being received has not has not risen in line of other commodities and is now not covering cost of production for many within the these industries: and with no end in sight of this rise - the end is in sight for many within these industries.

    Biofuel policy clearly has fueled the rise in biiofuels's popularity. This in turn has increased the demand for land and also for traditional crops grown on this land; which knocks on to an increase in there respective prices. This leads to the intense pressure on industries which have to come to depend on these feeds.

    How many governments of the main grain producing countries have incentivised biofuels production is a question I don't have an answer to and as a result am unsure how much of a driver this is becoming and much the pressure will increase by on livestock producers.

  3. If the oil price rise in 2008 to over $140 (nearly a triple in 18 months) and the subsequent price decline (crash) to under $40 in a few months was not a speculative bubble (popping) because there was no inventory buildup, was it some other kind of bubble? Or is that just price volatility in your vernacular?

  4. 60 mins did a special on that oil price spike ('The Price of Oil') here is a summarised version:;lst;4

    Demand went down, supply went up, but price went up and up.

    Consumption in the grain market has gone up moderatly this year, while supply has been steady. I know it is a sensitive market but the dramatic increase over a relatively short space of time would seem to indicate that speculation is at least a playing a minor role - for good or for bad.

  5. So please explain exactly what swap dealers are douing in grains today. Their extreme net long positions have nothing to do with price. These positions are at full margin. So what are they doing in grains? FYI- They are bigger then managed money and true commercials.

  6. A few short points:

    Yes, speculators participate in the market, and probably more so when fundamentals are shifting like they are today. But these are good for the market: If speculators anticipate demand to be a lot higher tomorrow than today, and don't expect supply will keep up, it's a good idea to store some of today production for consumption tomorrow. The way this happens is that speculators, anticipating tomorrows higher demand, drive up futures prices. With futures prices above spot prices, it then pays to sell less and store more. One of the best examples was when the market anticipated the ethanol runnup in corn demand and this caused storage on a massive scale before the ethanol plants came online. Those stores were quickly depleted once ethanol plants were up and running.

    If you think speculators are all wrong about supply and demand today or in the future, there is money lying on the table. Go pick it up.

    No, I don't think oil was a bubble. Something strange happened for a week or two. But it's very easy to explain the big rise and subsequent drop with fundamentals. The boom was due to tight supply and robust demand. Inventories were generally low. Again (I'm beating a dead horse) you can't have a bubble without inventory growth, which didn't happen, and everyone was producing flat out. Prices fell with the Great Recession--a huge unexpected fall in demand.

    Now, I'm not saying bubbles never happen. I think the real estate market was a bubble. So was the stock market around 2000. But I think bubbles are rarer with commodities. Plus, we're seeing some powerful fundamentals right now, just like we did in 2008. Indeed, they are the same fundamentals stemming from robust growth in emerging markets.


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