baffes and haniotis

7/30/2019 Baffes and Haniotis

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Policy Research Working Paper 5371

P t 2006/08 Cmmdt P Bmt Ptv

John Baes

assos Haniotis

T Wd BDvmt Pt Gu

Ju 2010

WPS5371


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Pdud b t R Sut m

Abstract

Te Policy Research Working Paper Series disseminates the ndings o work in progress to encourage the exchange o ideas about development

issues. An objective o the series is to get the ndings out quickly, even i the presentations are less than ully polished. Te papers carry the

names o the authors and should be cited accordingly. Te ndings, interpretations, and conclusions expressed in this paper are entirely those

o the authors. Tey do not necessarily represent the views o the International Bank or Reconstruction and Development/World Bank and

its afliated organizations, or those o the Executive Directors o the World Bank or the governments they represent.

Policy Research Working Paper 5371

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3/42

Placingthe2006/08CommodityPriceBoom

intoPerspective

JohnBaffes

[email protected]

TassosHaniotis

EUROPEANCOMISSION

[email protected]

Theviewsexpressedinthispaperarethoseoftheauthorsandshouldnotbeattributedtotheir

affiliatedinstitutions.WewouldliketothankAtamanAksoy,JulieDana,BettyDow,ChrisGil

bert,LouisGoreux,BernardHoekman, andGaureshRajadhyaksha for commentsand sugges

tionsonpreliminarydrafts.RachelWeavingprovidedexcellentediting.Thepaperisacontribu

tiontotheWorldBankDFIDGlobalTradeandFinancialArchitectureproject.


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Page2

1.Introduction

The200608commodityboomwasoneof the longestandbroadestof thepost

WWIIperiod.Theboomand especially the 2008 rally,when crudeoilprices

peaked atUS$ 133/barrel (up 94 percent from a year earlier) and rice prices

doubledwithinjustfivemonthshasrenewedinterestinthelongtermbehavior

and determinants of commodity prices, and raised questions about whether

commoditypriceshave reversed thedownward course thatmost of them fol

lowedduringmostofthepastcentury.1Ithasalsoproducednumerouscallsfor

coordinatedpolicyactionsatthenationalandinternationalleveltoaddressfood

availabilityandfoodsecurityconcerns.2

Toput therecentcommodityboom intoperspectivecalls foragoodun

derstandingofthekeycharacteristicsanddeterminantsoflongtermcommodity

pricemovementsandanappreciationofhowlimitedthisunderstandingis,es

peciallywith respect to theconditionsunderwhich the recentboomunfolded.Suchaperspectiveisimportantinordertoavoidpolicypitfallsthatinthename

ofmitigatingfoodsecurityconcernsorimprovingthefunctioningofthemarkets

may,infact,exacerbateexistingproblems.

Thispaperhastwoobjectives.Thefirstistoanalyzethenatureofthere

centboom,especiallyinfoodcommodities,byexaminingwhichkeyfactorsfu

eled itandwhethersuch factorsare likely to remain inplace in the long term.

Thesecondobjective is toplace theboom intoperspectivebyexamining long

term trends and characteristics of commodity prices. The next sectionbegins

withadiscussion

of

recent

price

trends,

including

the

causes

of

the

boom

as

well

asacomparisonwithearlierepisodesofhighprices.Particularattentionispaid

tothreekey(realorperceived)causesoftheboom:excessliquidityandspecula

tion,fooddemandgrowthbyemergingeconomies,anduseofsomefoodcom

moditiestoproducebiofuels.Section3analyzesthelongtermbehaviorofcom

modityprices, including stationarity,comovementamongpricesof foodcom

modities,and theprice linkbetweenenergyandnonenergycommodities.The

finalsectionsummarizesanddiscusses somepolicy issues, including the ratio

nalityandviabilityofproposalsfordealingwithpricespikes.

We conclude that a stronger linkbetween energy andnonenergy com

moditypricesislikelytohavebeenthedominantinfluenceondevelopmentsincommodity, and especially food,markets.Demandbydeveloping countries is

unlikely tohaveputadditionalpressureon thepricesof foodcommodities,al

thoughitmayhavecreatedsuchpressureindirectly throughenergyprices.We

alsoconclude that theeffectofbiofuelson foodpriceshasnotbeenas largeas

originally thought,but that the use of commoditiesby investment fundsmay

havebeenpartlyresponsibleforthe2007/08spike.Finally,econometricanalysis


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ofthelongtermevolutionofcommoditypricessupportsthethesisthatpriceva

riabilityoverwhelmspricetrends.

2.TheNatureandCausesoftheRecentCommodityBoom

The recent commodityboomemerged in themid2000safternearly threedec

adesoflowanddecliningcommodityprices(Figure1).Thelongtermdeclinein

realpriceshadbeenespeciallymarkedinfoodandagriculture.Between197576

and200001,world foodpricesdeclinedby53percent in realUSdollar terms.

Suchpricedeclinesraisedconcerns,especiallywithregardtothewelfareofpoor

agriculturalproducers.Infact,oneoftheDohaRoundschiefmotives(andalso

oneof itsperceivedmain obstacles)was the reduction of agricultural support

andtradebarriersinhighincomecountriesasetofreformsthatwasexpected

toinduceincreasesincommoditypricesandhenceimprovethewelfareoflow

income commodity producers (Aksoy and Beghin 2005). Starting in themid2000s,however,mostcommoditypricesreversedtheirdownwardcourse,even

tuallyleadingtoanunprecedentedcommoditypriceboom.

Between2003and2008,nominalpricesofenergyandmetalsincreasedby

230percent, thoseoffoodandpreciousmetalsdoubled,and thoseoffertilizers

increased fourfold. Theboom reached its zenith inJuly 2008,when crude oil

prices averagedUS$ 133/barrel,up 94percent from a year earlier.Riceprices

doubledwithinjustfivemonthsof2008,fromUS$375/toninJanuaryto$757/ton

inJune.

Therecentboomshares twosimilaritieswith the twoearliermajorcommodityboomsof thepostWWIIperiod,during theKoreanWarand theearly

1970senergycrisis(seeRadetzki(2006)foradiscussionofthethreebooms).Each

ofthethreeboomstookplaceagainstabackdropofhighandsustainedeconomic

growthaswellasanexpansionarymacroeconomicenvironment,andeachwas

followedbyasevereslowdownofeconomicactivity.Andallthreetriggereddis

cussionsoncoordinatedpolicyactionstoaddressfoodandenergysecuritycon

cerns.

Yettherecentboomalsoshowssomeimportantdifferencesfromthepre

viousones.Bymostaccounts,itwasthelongestlastingandthebroadestinthe

numbersofcommodities involved. Itwas theonlyone that simultaneously in

volvedallthreemaincommoditygroupsenergy,metals,andagriculturewith

itspeakshowingfoodandagriculturepricesincreasinglessthanallothercom

modityprices(WorldBank2009).Itwasnotassociatedwithhigh inflation,un

liketheboomofthe1970s(althoughtheincreaseinfoodpriceshadsomenota

ble,albeit shortlived, impacton inflation).Finally, itunfolded simultaneously

with the development of two otherboomsin real estate and in equitymar


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ketswhoseend ledmostdevelopedcountries to theirmostseverepostWWII

recession.

The recentboom tookplace inaperiodwhenmostcountries,especially

developingones,sustainedstrongeconomicgrowth.During200307,growthin

developingcountriesaveraged6.9percent, thehighest fiveyearaverage in re

centhistory (Figure2).Yetapart frombroadandprolongedeconomicgrowth,

thecausesoftherecentboomwerenumerous,includingmacroandlongtermas

wellassectorspecificandshorttermfactors.

Fiscal expansion inmany countries and laxmonetarypolicy created an

environment that favoredhigh commodityprices.3Thedepreciationof theUS

dollarthecurrencyofchoiceformost internationalcommodity transactions

strengtheneddemand(andlimitedsupply)fromnonUS$commodityconsumers

(andproducers).Other important contributing factors include lowpast invest

ment,especiallyinextractivecommodities;4investmentfundactivitybyfinancial

institutionsthatchosetoincludecommoditiesintheirportfolios;andgeopoliticalconcerns,especiallyinenergymarkets.

Inthecaseofagriculturalcommodities,priceswereaffectedbythecom

binationofadverseweatherconditionsandthediversionofsomefoodcommod

itiestotheproductionofbiofuels(notablymaizeintheUSandedibleoilsinEu

rope).That led toglobalstocktouseratiosofseveralagriculturalcommodities

down to levelsnotseensince theearly1970s, furtheraccelerating theprice in

creases(Figure3).Policyresponsesincludingexportbansandprohibitive taxes

thatwereintroducedin2008tooffsettheimpactofincreasingworldfoodprices

contributedtocreatingtheconditionsfortheperfectstorm.Theweakeningand/orreversalofthesefactors,coupledwiththefinancial

crisisthateruptedinSeptember2008andthesubsequentglobaleconomicdown

turn, induced sharppricedeclinesacrossmost commodity sectors.But though

commoditypriceshavedeclinedsharplysincetheirmid2008peak,theypicked

upagainrecentlyandthekeycommoditypriceindicesarestilltwiceashighas

theirearly2000slevels(Figure4).

Thus thekeyquestion iswhetherat leastsomeof thefactorsbehind the

recentboomaremorepermanent innature,and likely to remain inplace.Past

experiencerevealsthatfoodcommoditypricespikesweremainlydrivenbyneg

ativesupplyshocks,withhighpricesoftenactingasthebestincentiveformiti

gatingtheshocksthatgeneratedthem.Yetthepertinenceofsuchexperiencefor

futuredevelopmentshasbeenquestioned,andinattemptstoexplainthecurrent

boom,somefactorshavereceivedconsiderablymoreattention(orevensubjected

toaconsiderableamountofmisinformation)thanothers.Withthisinmind,the

restofthissectionexaminesthecontributionsmadebythreesuchfactors,name

ly, excess liquidity and speculation, income growth and dietary changes in


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emerging economies, and the diversion of some food commodities tobiofuel

production.

Excessliquidityandspeculation

Duringthecourseoftherecentboom,ithasbeenarguedoftenthatfundamentalsdonottell thewholestoryandcommoditypriceshavebeendriven,inpart,by

factors that go beyond demand and supply considerations. Excess liquidity,

whichisoftenplacedwithinthebroadercontextofspeculation,isoftenargued

tohavefueledacommoditybubble.

Togaugetheimportanceoftheissue,considerthefollowing.Betweenthe

secondhalfof2007andthefirsthalfof2008productionofpetroleumincreased

from85.8millionbarrelsperday (mb/d) to86.8mb/d.Consumption fell from

86.5mb/d to86.3mb/d.Pricesshouldhave fallen. InDecember2007,crudeoil

averagedUS$ 90/barrelwhile inJune 2008 it averagedUS$ 132/barrel, almost

50% up. Recent figures on spare capacity give an equally perplexing picture.

During2009,OPECsparecapacitystoodat6.3mb/dwhilepetroleumpricesav

eraged$62/barrel.However,similarcapacitylevelsduringtheearly2000swere

associatedwith $20/barrel. Stocks of key food commodities are 20% higher in

2009/10 compared to 2007/08; yet the nominal foodprice index averaged 23%

higherinDecember2009comparedtoayearago,rathersurprisinggiventhatan

oftencitedreason for the foodpricespikeof2008was low inventories.Admit

tedly, theapparentdivergencebetweencommoditypricesand fundamentals

deserves(andhasreceived)attention.

While fundamentals haveplayed a key role in commoditypricemovements,observationssuchastheabovehaveledmanyresearchersandanalyststo

argue that the commodity priceboom reflected, in part, excess liquidity and

speculation. Inotherwords,a lotofnewmoney (aresultofexcess liquidity)

chasedtoofewassetsandeventuallyfounditswayintocommoditymarkets,in

turncausingaspeculativebubble.

Variousconcepts related to speculationhavebeendiscussedoften inter

changeablyandhavebeenanalyzedinisolationfromeachother,ortheyarepre

sented inanoversimplifiedmanner,especially invariouseditorialsandblogs.

Theseconcepts

include:

excess

liquidity

(one

of

the

three

sources

of

new

mon

ey); index fund activity (the chief investment vehicle for the newmoney);

speculation(anactivitynotwelldefinedbutnecessaryforthefunctioningoffu

turesexchangesandsometimes thesourceofmarketmanipulation); theroleof

commodity futuresexchanges (thenervecentersofcommoditypricediscovery

mechanisms); inventories (which matter most for nonperishable agricultural

commodities,mostlygrains);andspeculativebubble(averybroadanddifficult


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toquantify issue).Notsurprisingly,suchcomplexityhas led todifferentviews

andmixedempiricalevidence.Theremainingofthissectionelaboratesonthese

concepts (seeAppendixA for adiscussionon speculation in commoditymar

kets).

Broadlyspeaking,thenewmoneywhichisnotassociatedwithphysi

calcommoditytransactionscanbelinkedtothreesources:

Diversificationofinvestmentvehicles.Duringthepastdecadeorso,investmentfundmanagersnoticedthatexistingassetclasseswerebecomingincrea

singlycorrelated.Intheirsearchfornew(uncorrelated)assetstheybroadened

theirportfoliosbyincludingassetsfromemergingeconomies.Whentheseas

setsbecamethemselvescorrelated(becauseofthesystemiceffectofallfunds

investedinthesameassets)fundmanagersbeganinvestingincommodities,

thus setting the stage for the socalled financialization of commoditiesa

roletypicallyreservedforgold,after1973.Totheextentthatcommoditiesare

viewedasanotherassetclass,diversificationmayhaveapermanentcharac

ter.

Rebalancingofinvestmentportfolios.Therebalancingofinvestmentportfoliosby shifting funds fromUS$denominated (andother)holdings to com

moditiesaddedfurtherinflowsintocommoditymarkets.Thestrong inverse

relationshipbetween theUS$andcommoditypricesespeciallycrudeoil

hasbeen invokedoftenasevidence for such rebalancing (seeMedlockand

Jaffe2009).5Theeffectof rebalancing is lesspermanent thandiversification

anddepends largely on how long investors risk attitudeswill favor com

moditiesordisfavorotherassets. Excessliquidity.Thelowinterestrateenvironmentsupportedbymanycentralbanks resulted inexcess liquidity,partofwhich found itsway tocom

moditymarkets (on top of theprice increasedue to expansion ofphysical

demandforcommodities).Itisbelievedthatexcessliquidityhasbeenthekey

reasonbehindtheboominrealestatemarkets.Theeffectofexcessliquidityis

likelytolastforaslongasinterestratesremainlow.

The key channel throughwhich the newmoney found itsway into

commoditymarkets is indexfunds.Themostwidelyusedandcloselywatched

indicesaretheDowJonesAIGandS&PGoldmanSachsCommodityIndex(alsoknownasDJAIGandS&PGSCI).About95percentof funds indexed tocom

modities are replicatedby these two indices.The funds take longpositions in

commodityfuturesexchangesbybuyingcontractsand,priortoexpiration,roll

ing themover.While therearenopreciseestimateson theirsize,abroadlyac

ceptedrangeasofmid2008was$250to$300billion(Masters2008).Areportby

amajorcommercialbankestimatedthatanadditional$60billonwentintocom


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moditiesduring2009,placing the2009totalestimateto$230240billion,margi

nallylowerfrom2008duetoweakercommodityprices.Althoughtheseamounts

ofmoneyrepresentaboutonepercentof theglobalvalueofpensionandsove

reignwealthfundholdings(bothkeycontributorstoindexfunds,withtheglob

alvalueof these twogroupsestimatedat$20and$4 trillion,respectively) they

arelargecomparedtothesizeofcommoditymarkets.6

Theeffectof thenewmoneyoncommoditypriceshasbeenassociated

withspeculationthatmighthaveledtoapricebubble.Theviewsonthesubject,

however,havebeen,forthemostpart,extreme.Forexample,Krugmaninase

riesofNewYorkTimesblogsandeditorials,notonlyrejectedtheviewthatspecu

lationfueledtheboombutalsodismissedtheideathatcommoditytradingactiv

ityinfuturesexchangesmayhaveaffectedcommoditypricesatall,arguingthat

afuturescontractisabetaboutthefutureprice.Ithasno,zero,nadadirectef

fecton thespotprice(NewYorkTimes,June23,2008).Others toohaveargued

thatspeculationplayednorole.Wolfisoftheopinionthatifspeculationwereraisingpricesabovethewarrantedlevel,onewouldexpecttoseeinventoriespil

inguprapidly,assupplyexceedstherateatwhichoilisburned.Yetthereisno

evidenceofsuchaspikeininventories(FinancialTimes,May13,2008).Frankel

citedtheCongressionaltestimonybythechiefeconomistoftheCommoditiesFu

turesTradingCommission(CFTC)onApril3,2008tosupportinhisweblog(Ju

ly25,2008) thatTheevidencedoesnotsupport theclaim thatspeculationhas

beenthesourceof,orhasexacerbatedthepriceincreases.Verleger(2009),based

on IEA (2009) analysis, concluded at hisCFTC testimony that the increase in

crudeoilpricebetween2007and2008wascausedbytheincompatibilityofenvironmentalregulationsandspeculationhadnothingtodowiththepricerise.7The

IOSCOTaskForce (2009), formedat therequestofG8 toexamine the issueof

speculationincommoditymarkets,foundthateconomicfundamentals,notspe

culative activity, are thepossible explanation for recentprice changes in com

modities.8Wright(2009)echoedsimilarviewsbynotingthatiflongfuturesposi

tionswerebehindthegrainpricespikeof2008,stockswouldhaveincreased.

At the other end of the spectrum, Soros (2008) called commodity index

tradingathisUScongressionaltestimonyintellectuallyunsound,potentiallydes

tabilizing, and distinctly harmful in its economic consequences.Eckaus (2008)

andKhan(2009)authoredpapersentitledTheOilPriceIsReallyaSpeculative

BubbleandThe2008OilPriceBubble,respectively.Calvo (2008)noted that

speculationandlowinventoriesarenotnecessarilyinconsistentwitheachother

andconcludedthat[increasesin]commoditypricesaretheresultofportfolio

shiftagainstliquidassetsbysovereigninvestors,sovereignwealthfunds,partly

triggeredbylaxmonetarypolicy,especiallyintheUS.Roubini(2009)saidthis

ontheearly2009crudeoilpriceincrease:improvingfundamentalsjustify


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oilgoingfrom$30tomaybe$50.Ithinktheother$30isallspeculativedemand

feedingonitspeculatorsandherdingbehavior.Similarviewswereechoedby

othersaswell,includingMedlockandJaffe(2009)andWray(2008).

Theempiricalevidenceon thesubjecthasbeenmixed.Two IMFstudies

(2006, 2008) found no evidence that speculation had systematically influenced

commodityprices.Asimilarconclusionwasreachedbyaseriesofstudiesunder

takenbytheUSCommoditiesFuturesTradingCommission,theagencythatre

gulatesUSfuturesexchanges.9Sanders,Irwin,andMerrin(2008)expressedskep

ticismabouttheassertionthatspeculationhasledtobubblesinagriculturalfu

turesprices.

Otherauthorssharesomewhatdifferentviews.Roblesandothers (2009)

identified speculative activity in the futuresmarket as a sourceof the 2007/08

agriculturalcommodityprice increases.Plastina (2008)concluded thatbetween

January 2006 andFebruary 2008, investment fund activitymighthavepushed

cottonprices14percenthigherthantheywouldotherwisehavebeen.Inthenonferrousmetalsmarket,Gilbert (2007) foundnodirectevidenceof the impactof

investoractivityon thepricesofmetals,butfoundstrongevidence that thefu

turespositionsof indexprovidershadaffected thepricesof soybeans (though

notofmaize) in theUS futuresexchanges.Perhaps, thestrongestevidence isa

subsequentstudybyGilbert(2010:420)whoconcludedthatByinvestingacross

theentirerangeofcommodityfutures,indexbasedinvestorsappeartohavein

flatedfoodcommodityprices.

Whyistheempiricalevidencemixed?Often it isargued thatdespite the

fact that investment fund activity remained steady or even increasedbetweenmid andend2008,pricesdeclinedsharplyduringthatperiod.Hence,theargu

mentgoes, investmentfundsdidnotaffectcommodityprices.However,that is

basedon the logic that if investment fund activity continued to increase, then

priceswould increase forever (or,at least theywouldnotdecline),anunlikely

outcome.Supplyanddemandfundamentalswillprevail,eventually.Thus,from

anempiricalperspective, thekeyquestion shouldbewhether investment fund

activity contributed to the recent boom (or any boom, for that matter), not

whetheritaffectscommoditypricesingeneral.Consequently,examiningtherole

ofinvestmentfundsincommoditymarketsrequiresfirst,theidentificationofthe

boomperiodandsecond,eitheranalyzethatperiodinisolationperhapswithin

aunivariatemodelingframeworkoruseofearlierperiods(orsomeotherprior)

ascounterfactuals.

Identifyingthesuspectperiodwillcontainalargeelementofsubjectivi

ty and hencewill inevitably lead todiffering opinions.However, there are at

leastthreereasonswhyinvestmentfundactivitymayhaveinfluencedcommodi

typrices.First,investmentincommoditiesisarelativelynewphenomenon,and


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fundshave todateflowedmostly in,notout, implyingthatsomemarketsmay

havebeensubjecttoextrapolativepricebehavior; thatis,highpricesleading to

morebuyingbyinvestmentfunds,inturnleadingtoevenhigherprices,andso

on.Infact,thatmayhavebeenthecasewiththesovereignwealthfunds,whose

revenuecomes fromcommodities,which in turn it is invested incommodities.

Second,indexfundsinvestonthebasisoffixedweightsorpastperformancecri

teria,andhence investmentoftenbehavesdifferently fromwhatmarketfunda

mentalswoulddictate.Third,thelargesizeofthesefundscomparedtocommod

itymarketsmayexacerbatepricemovements.Or,asSoros(2008:3)characteristi

callyputittheinstitutionsarepilinginononesideofthemarketandthey

havesufficientweighttounbalanceit.

Whatconclusioncanbederivedfromofallthisinthecontextofexcessli

quidityandspeculation?Wasinvestmentfundactivityatleastpartlyresponsible

fortherecentcommodityboom?Anycommodityrelatedactivityonthefinancial

side isunlikely toalter longtermprice trends,whichwillultimatelybedeterminedbymarketfundamentals.But,suchactivitiescan inducehigherpriceva

riabilityinthesenseofexacerbatingthelengthandtheamplitudeofpricecycles,

astheymostlikelydidduringtheperfectstormof2007/08.

Dietarychangesandincomegrowthinmiddle-incomecountries

Typicallyagriculturalpriceboomsare linked tosupplyshockssuchasweather

events or animal diseases that disturb normal production patterns. Supply

shockswerenoexception in the recentboom.Droughtsplayedamajor role in

thereductionofdairyexports fromNewZealand.Australiasgrainproductionwasseverelyaffectedbythethreedroughtsexperiencedduring2002/08(ahighly

unusualweatherpattern,often linked toglobalwarming).The2009drought in

SouthAmericaaffectedtheoilseedsmarketformorethanayear.Butthemagni

tude of these events, although cumulative and coming after a long period of

normalweatherpatterns, falls short of explaining the extent of the foodprice

spike.

Could ademand shockoffer amoreplausible explanation, ashasoften

beensuggested?Forthistohavebeenthecase,suchashockshouldhavetaken

placeeither

unexpectedly

and

suddenly

or

through

arapid

shift

in

long

term

ex

pectationsaboutfooddemandpatterns.Ithasoftenbeenarguedthatastructural

shifthas takenplace in thedemand forgrainbyemergingcountries, including

ChinaandIndia,andespeciallyduringthepastdecadewhenthesetwocountries

experiencedhighincomegrowth.TheJune2009issueofNationalGeographic,for

example, noted that as countries like China and India prosper and their

peoplemoveup thefood ladder,demandforgrainshas increased.Similarar


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gumentshavebeenadvancedbynoted scholarsaswell.Krugmanargued that

theresthemarchofthemeateatingChinesethatis,thegrowingnumberof

people inemergingeconomieswhoare, for the first time, richenough to start

eatinglikeWesterners(NewYorkTimeseditorial,April7,2008).Likewise,Wolf

askedSowhyhavepricesof food risen so strongly?and thenanswered

strongrises in incomesperhead inChina, India,andotheremergingcountries

haveraiseddemandforfood,notablymeatandtherelatedanimalfeeds(Finan

cialTimes,April29,2008).Indeed,thesizeofChinaandIndia,whichtogetherac

countfor27percentoftheworldspopulation,impliesthatevenaminorchange

intheirpatternofdemandgrowthhasamajoreffectonworldmarketprices.

Butacloserlookatthegrowthtrendsofpopulationandincomeoverthe

pastdecades, coupledwith those ofdemand for food commodities, showsno

evidence that fooddemandgrowthacceleratedeither inChinaand Indiaor in

theworldasawhole.Table1summarizesdemandgrowthpatternsforanumber

ofkeyfoodcommoditiessince1961forfour12yearperiodsroughlycorrespondingtofourpricecycles:theperiodofthegreenrevolution(196172);theafter

mathofthetwoenergyshocks(197384),therecoveryofagriculturalpricesuntil

theirmid1990sprice spike (198596),and the lastperioduntil the recentprice

peak(199708).Thedataclearlyshowthatdemandgrowthhasslowedformost

grainsincluding thoseused for feed, reflectinga slowdown in thegrowthof

demandformeat.

Duringthemostrecentdecade,despiteaclearaccelerationofGDPgrowth

since2003,strongerdemandforagriculturalproductsbothatworldlevelandin

Chinaand Indiahasbeen theexceptionitoccurred inmaizeand insoybeans(drivenbydemandforedibleoils),andwasrathermixedingrains,butcertainly

didnotoccur inmeatsordairyproducts (seeTable2withabreakdownof the

19972008period for theworld,China,and India).Similar findingson the role

(or,thenonrole)ofChinaandIndiahavebeendiscussedinAlexandratos(2008:

673)whoemphaticallystatedthattheir[ChinasandIndias]combinedaver

age annual increment in consumption (both growth rates and absolute incre

ments)waslowerintheyearsofthepricesurges,200208,thaninthepreceding

period19952001.FAO(2009)arrivedatnearlyidenticalconclusions.

These developments reflect the huge gap that existed during the price

boombetweenthefundamentalsofagriculturalmarketsandthecorresponding

price levels.No other example demonstrates thisbetter than the fact that the

highestprice increases tookplace in twocommoditieswheatandricewhere

fooddemandwasstagnatingandyetwerewidelyexplainedasbeingdrivenby

strongfooddemand.Thus,whilesupplyshocksmayexplainsomeof theprice

pressures incertain foodcommodities,bycontrastdemandgrowthaccelerated

inrecentyearsincommoditiesusedforbiofuels,suchasmaizeandedibleoils.


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Biofuels

The increasing interactionbetween the pricemovements of energy and non

energycommoditiesduring theboomfocusedattentionontheimpactofgrow

ingdemand forbiofuels, including formaizebasedethanol (mainly in theUS)

and oilseedbasedbiodieselproduction (mainly inEurope).During theboom,maizeandcrudeoilpricesmovedintandem,pointingtoanemergingnewand

fixedrelationshipbetweenthem.Obviously,maizeanditsuseforethanolmoved

into the picture as significant factors affecting price developments. But how

much impactwas there,andwasthereasimilaroneinoilseeds,resultingfrom

theiruseforbiodiesel?

Thecontributionofbiofuels to the recentpriceboom,andespecially the

pricespikeof2007/08,hasbeenhotlydebated.Mitchell (2009)argued thatbio

fuelproductionfromgrainsandoilseedsintheUSandtheEUwasthemostim

portantfactorbehindthefoodpriceincreasebetween2002and2008,accounting,perhaps, forasmuchas two thirdsof theprice increase.Gilbert (2010),on the

otherhand, found littledirectevidence thatdemand forgrainsandoilseedsas

biofuelfeedstockswasacauseofthepricespike.

FAO (2008) compared abaseline scenario,which assumes thatbiofuel

productionwilldoubleby2018, toanassumption thatbiofuelproductionwill

remainatits2007levels;itconcludedthatinthelattercasegrainpriceswouldbe

12percent lower,wheatprices7percentlower,andvegetableoilprices15per

centlowerthaninthebaselinescenario.OECD(2008)arrivedatsimilarconclu

sionsforvegetableoils,findingthattheirpriceswouldbe16percentlowerthan

thebaselineifbiofuelsupportpolicieswereabolished;eliminatingbiofuelsubsi

dieswouldhavesmaller impactson thepricesofcoarsegrains(7percent)and

wheat (5percent).Rosegrant (2008),who simulatedmarketdevelopmentsbe

tween2000and2007(excludingthesurgeinbiofuelproduction),concludedthat

biofuelgrowthaccountedfor30percentofthefoodprice increasesseeninthat

period,withthecontributionvaryingfrom39percentformaizeto21percentfor

rice.Lookingahead,Rosegrantfound that ifbiofuelproductionweretoremain

atits2007levels,ratherthanreachingitsmandatedlevel,maizepriceswouldbe

lowerby14percentin2015andby6percentin2020.10

Banseandothers(2008)comparedtheimpactoftheEUscurrentmandateto(i)anomandatescenarioand(ii)amandatewherebytheUS,Japan,Brazilal

soadopttargetsforbiofuelconsumption.Theyestimatethatby2020,inthebase

linescenario (nomandate),cerealandoilseedpriceswillhavedecreasedby12

and7percent,respectively.IntheEUonlyscenario,thecomparablechangesare

7percentforcerealand+2percentforoilseeds.Bycontrast,undertheglobal

scenario(addingbiofueltargetsinUS,Japan,andBrazil)oilseedpriceswillhave


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risenby19percentandcerealpricesbyabout5percent.TheEuropeanCommis

sionsownassessmentofthelongterm(2020)impactsofthe10percenttargetfor

biofuels(i.e.thatrenewableenergyfortransport,includingbiofuels,willsupply

10 percent of all EU fuel consumptionby 2020) predicts fairlyminor impacts

fromethanolproduction,whichwouldraisecerealsprices36percentby2020,

butlargerimpactsfrombiodieselproductiononoilseedprices;thegreatestpro

jectedimpactisonsunflower(+15percent),whoseglobalproductionpotentialis

quitelimited.Taheripourandothers(2008)simulatethebiofueleconomyduring

200106.Byisolatingtheeconomicimpactofbiofueldrivers(suchasthecrudeoil

priceand theUSandEUbiofuelsubsidies)fromotherfactorsataglobalscale,

theyestimatetheimpactofthesefactorsoncoarsegrainpricesintheUS,EU,and

Brazilat14percent,16percent,and9.6percent,respectively.

AjointUSDepartmentofAgricultureandDepartmentofEnergyassess

ment (USDA/USDE2008)concluded that the recent increase inmaizeandsoy

beanpricesappears tohave little todowith therunup inpricesofwheatandrice.Itfoundthatiftheamountsofcornusedforethanolandedibleoilusedfor

biodiesel in theUS had remainedunchanged at their 2005/06 levels,prices in

2007/2008wouldhavebeen15percentlowerformaize,18percentforsoybean,

and13percentforsoybeanoil.Theassessmentalsoconcludedthattheimpactof

biofuelsproductionin2007wasa34percentincreaseinretailfoodpricesanda

0.10.15percentincreaseintheallfoodCPI.

ClearlyUSmaizebased ethanolproduction, and (to a lesser extent)EU

biodieselproduction)affected thecorrespondingmarketbalancesand landuse

inbothUSmaize and EU oilseeds.Yet,worldwide,biofuels account for onlyabout1.5percentoftheareaundergrains/oilseeds(Table3).Thisraisesserious

doubtsaboutclaimsthatbiofuelsaccountforabigshiftinglobaldemand.Even

thoughwidespreadperceptionsaboutsuchashiftplayedabigroleduring the

recentcommoditypriceboom,itisstrikingthatmaizepriceshardlymoveddur

ing the first period of increase inUS ethanol production, and oilseed prices

droppedwhen theEU increased impressively itsuseofbiodiesel.On theother

hand,pricesspikedwhileethanolusewasslowingdownintheUSandbiodiesel

usewasstabilizingintheEU.

Yetwhilethedebatehasfocusedmostlyontheamountoffoodcropsthat

havebeendivertedtotheproductionofbiofuels,andtheresultingeffectonpric

es,lessattentionhasbeenpaidtoamoreimportantissuelinkedtothisdevelop

mentthe level atwhich energy prices provide a floor to agricultural prices.

Analytically,thisisaverycomplexissue;inadditiontothepricesoftherespec

tivecommodities(energyandfeedstockforbiofuels),itinvolvesnumerousother

elements,includingsubsidies,mandates,traderestrictions,andsunkcostsofthe

biofuelindustry.Therefore,analystsoftenusevariousrulesofthumbtoexpress


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aperceivednewrelationshipbetweenagriculturalandcrudeoilprices.Onesuch

ruleisthatthepriceofmaizeexpressedinUS$/tonisroughlydoublethepriceof

crudeoil inUS$/barrel (thus aUS$ 75/barrelprice for crudeoilwould corres

pond toUS$150/ton formaize).Other commentators (in theUS)have argued

thatapriceofUS$3/gallonofgasolineatthepumpisthelevelatwhichthema

izeprice isdeterminedby thecrudeoilprice.TheWorldBank (2009) reported

that crude oil prices aboveUS$ 50/barrel effectively dictatemaize prices; this

conclusionwasbased on the strong correlationbetween themaize price and

crudeoilpricesaboveUS$50/barreland theabsenceofcorrelationbelow that

level.TheUSGovernmentAccountabilityOffice (2009:101)whileacknowledg

ingthateconomistshavedisagreedaboutthecircumstancesthatwouldmakethe

2009USbiofuelmandatesnonbinding(i.e.biofuelsbecomeprofitableatcurrent

energyprices), itgavearangebetween$80and$120perbarrel (therangewas

basedonanecdotalevidencebasedon interviews).Theempiricalbasisofsuch

rulesislinkedtotheissuediscussedinthenextsection.

3.CommodityPrices:LongertermTrends

This section focuseson threekey characteristicsof commoditypricebehavior:

lackof trends,comovementamongprices,andaspecialcaseof the latter, i.e.,

thelinkbetweenenergyandnonenergycommodityprices.

Trends,cycles,andeverythinginbetween

The longtermbehaviorofcommoditypriceswas firstexaminedsystematicallybyPrebisch (1950)andSinger (1950),whonoted thatsince the late19thcentury

thepricesofprimary commoditieshadbeendeclining relative to thepricesof

manufacturedgoods(oftenreferredtoasthebartertermsoftrade).Theywarned

ofpotentialproblemsforproducersofprimarycommodities,andinfacttheno

tionofdeclining termsof trade formed thecornerstoneof the industrialization

policiesthatmanydevelopingcountriespursuedduringthe1960sand1970s.

ThesocalledPrebischSinger(PSH)hypothesishasbeen,perhaps,oneof

themost researched topics in commodity pricebehavior. Early research (e.g.,

Spraos 1980; Sapsford 1985;Grilli and Yang 1988),which focusedmainly onidentifying trends, supplied broad support for PSH. However, later authors

foundthatpricesdidnotsimplymovealongalineartrendbutinsteadcontained

strongstochasticelements, i.e., longand irregularcycles, thusproducingmore

mixedresults(e.g.,CuddingtonandUrzua1989;Cuddington1992).Studiesus

ingbettereconometric techniquesand longer timeseriesallowed forstructural

breaks (e.g.,Leon and Soto 1997;Zanias 2005;Kellard andWohar 2006).And


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very recent literature, focusingonnonlinearor timevaryingalternatives (e.g.,

BalagtasandHolt2009),findsevenlesssupportforPSH.

All thisresearch isperhapsbestsummarizedbyCashinandMcDermott

(2002)whoconcluded that thedownward trend in realcommodityprices isof

littlepolicy relevancebecause it is smallwhen compared to the variability of

prices.OrasDeaton(1999:27)succinctlyputit,whatcommoditypriceslackin

trend,theymakeupforinvariance.

Commodityprice variability is at the core of the currentpolicydebate.

The difficulty associatedwith describing past pricebehavior, and hencewith

making inferences regarding future trends, canbe inferred fromFigure 1; the

conclusionsreacheddependonwhattimeperiodischosenforanalysis.Statisti

cally, thisdifficultyreflects theproblemofnonstationarity, i.e. the fact that the

averagepricedoesnotexistinthestatisticalsense.Table4showstheresultsof

ananalysisofstationarityforpricesofsixfoodcommodities(wheat,maize,rice,

soybeans,soybeanoil,andpalmoil).Forsensitivitypurposes,wereportresultsfromtwotests,withandwithouttrend,bothinnominalandrealterms(wealso

usedUSCPI inaddition toMUVand theresultswereremarkablysimilar).All

lendstrongsupporttononstationarity,thusreaffirmingtheconclusionsreached

byCashinandMcDermott(2002)andDeaton(1999).

Thefactthatcommoditypricevariabilityoverwhelmstrendshasanum

ber ofkey implications.On themethodological side, analysis involvingprices

needstorecognizethatcorrelationsmaynotbemeaningfulunlesscertaincondi

tionsaremet (seenextsection),andalso thatbecauseameanora trendof the

priceseriescannotbeproperlydefined,thevariabilityinpricesisdifficulttocalculate.

Onthepolicyside,attemptstointroducemechanismswithpricetriggers

(as has oftenbeenproposed recently) are likely to fail. In fact, the absence of

trends (orsimplyput, thenonexistenceofanaverageprice)maybe thekey

reasonwhyearlierpricestabilization(orother)mechanismsfailed.11Whenprices

stay low for longperiods, stabilization funds run out of resources, andwhen

pricesstayhighforlongperiods,stabilizationfundstendtobemisused.Consid

er,forexample,thattheagriculturalcommoditypriceindex(showninFigure1)

exceededitsperiodaverage(equalto173)inallyearsduring194871andfellbe

lowitinallyearsduring19812007.

Co-movement

Becausesomeagriculturalcommoditiescanbesubstitutedforoneanother(e.g.

variousedibleoils),whileresourcesontheinputside(e.g.,land,labor,andma

chinery)canbeshiftedfromonecroptoanother,thechangesinfundamentalsor


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Page15

policyactions inonemarketwilleventuallybe transmitted toothermarketsas

well.Thus,assessinghowthepricesofvariousfoodcommoditiesmovewithre

spect to eachother isparamount inunderstanding theway and thedegree to

whichmarketconditionsandpoliciesaffectprices.Examiningsuchrelationships

ultimately comesdown toestimating thedegreeofprice comovementamong

variouscommodities.

Whilethegeneralsubjectofpricecomovementhasbeenextensivelystu

died in the literature, analysis of the comovement among prices of different

commodities is scarce. (Forabrief literature reviewofpricecomovementand

thereasonswhytheissuehasnotbeenadequatelyresearchedseetheAppendix

B.)

Hereweanalyze the comovementofpricesusinga simpleeconometric

model.Thedegreeof comovementwas analyzed among six food commodity

prices,usingordinaryleastsquareswithannualdatafrom1960to2008:Pti=+

1Ptj+2MUVt

+3t

+t,

wherePtiandPtjdenotethelogarithmofcommodityprice

iandjinyeart(expressedinnominaldollarterms),MUVtdenotesthedeflator,t

isthetimetrend,andtdenotestheerrorterm;,1,2,and3areparametersto

beestimated.

TheresultsarereportedinTable5.Becausepricesarenonstationary(see

previoussection)examiningthestationaritypropertiesoftheerrortermisacru

cialstepinestablishingthevalidityofthemodel.Alltheregressionsshowstrong

performance,withanaverageR2of0.84andwithunitrootstatisticsthatstrongly

confirm thestationarityof theerror term.Moreover, inallcases the slopeesti

mateofthepricevariableissignificantatthe1percentlevel.Theresults imply that it is importantnot toanalyzecommoditymarkets

inisolationfromoneanother,becausetheimpactofeventsthatseeminglyaffect

onemarketwilleventuallybeequalizedamongmostcommoditysectors.Con

sider,forexample,thepalmoil/soybeanoilparameterestimateof0.97andanR2

of0.93(Table5,bottomrow).Thissuggestsanalmostsynchronousmovementof

palmandsoybeanoilprices,despitethefact thatsoybeanoil isanannualcrop

producedchiefly inNorthandSouthAmericaandpalmoil isa treecroppro

ducedalmostexclusively inEastAsia.The implication is that,whetherbiofuel

mandates are applied to one or the other edible oilmarket, the effectwillbe

eventuallydiffusedamongalledibleoilmarkets.Not surprisingly,policies fa

voringbiofuelproductioninthenameofenvironmentalbenefitsmayinfactlead

to lessdesirable outcomes.That is, the environmentalbenefits from switching

from fossil fueluse to,say, rapeseedbasedbiodiesel inEuropeorsoybeanoil

basedbiodieselintheUSmaybelessthantheenvironmentalcostsofexpanding

palmoilproduction inEastAsia.12Similarly,pricesofwheat,maize, and soy

beanskeyfoodcrops,producedprimarilyintheUS,EU,andSouthAmerica


18/42


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(Table7,toprow).15Whenthesampleunderlyingthecurrentanalysisisadjusted

tomatchthesamplesusedinthesestudies,thepassthroughcoefficientbecomes

remarkablysimilar,at0.13,0.12,and0.18,respectively.

Underlying these aggregate passthrough coefficients for nonenergy

commoditypricesarevariationswithinsubindices.Amongthesubindices,the

highestpassthroughelasticityisinfertilizer,at0.55notsurprisingly,sinceni

trogenbasedfertilizersaremadedirectlyfromnaturalgas.Interestingly,thefer

tilizerandenergypriceincreasesduringtherecentboomwereinlinewiththose

experienced during the first oil shock: from 1973 to 1974 phosphate rock and

ureapricesincreasedfourfoldandthreefold,whilethecrudeoilpriceincreased

fromUS$2.81/barreltoUS$10.97/barrel.

The passthrough elasticity for agriculture, estimated at 0.27, reflects a

wide range among the components of the agriculture index:beverages (0.38),

food(0.27),andrawmaterials(0.11).Forthecomponentsofthefoodpriceindex,

bycontrast,theelasticityestimatesfallwithinaverynarrowrange:cereals(0.28),edibleoils(0.29),andotherfood(0.22).Basedonthesameregression,Table8re

portsparameterestimatesforthesixfoodcommoditiesunderconsideration.The

estimatesforallsixfallwithinanarrowrange,fromalowof0.27inmaizetoa

highof0.36insoybeanoil.Thisresultcontrastssharplywithestimatesformet

als,whichshowahighdegreeofdiversity(seeChaudhri2001;Baffes2007).

Anumberofkeyconclusionsemergefromtheseresults.First,thepricesof

mostcommoditiesrespondstrongly toenergyprices,with theresponsefurther

strengthening inperiodsofhighprices (thevaluesof theestimatedelasticities

increaseconsiderablywhen the recentboom is included in theanalysis).Moreimportantly, thedifferencebetween the last twoestimates(last twocolumnsof

Table7)indicatesthattheeffectofenergypricesonthepricesofallcommodities

has increasedconsiderablywhen therecentboom is taken intoconsideration

suggesting that the energy/nonenergyprice linkhas strengthened (see earlier

discussion).Manyobservershaveattributedsuchstrengtheningof therelation

shiptotheuseofbiofuels,whichalsocoincides(roughly)withtheboom.Yet,it

isimportanttonotethatthestrengtheningoftheeffectofenergyonnonenergy

prices ismore pronounced in nonfood commodities (e.g. rawmaterials and

metals)thaninfood.Thus,commonfactorsappeartohaveplayedamoreprom

inentroleintherecentboom(seeVansteenkiste2009;Gilbert2010).

Second,foodcommoditypricesrespondtoenergypricesbymovingina

verysynchronousmannersince theelasticities fallwithinaverynarrow range

(from0.25to0.36).Suchresultnotonlyemphasizestheinterdependenceofagri

culturalmarkets (asdiscussedearlier)butalso indicates thatsinceakeydeter

minantof food commodityprices isenergyprices, analyzing foodmarkets re

quiresanunderstandingofenergymarketsaswell.


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Third,thoughthetransmissionelasticitiesofenergypricestononenergy

pricesarebroadlysimilar tooneanother, this isnot thecasewith the inflation

coefficient,estimatesofwhichvaryconsiderablyinsign,magnitude,andlevelof

significance.The inflationcoefficient ispositiveandsignificantlydifferentfrom

zero only for agriculture and some of its subindices, and effectively zero for

metals and fertilizers.This implies that the relationshipbetween inflation and

nominalcommoditypricesismuchmorecomplexand,perhaps,changingover

time.Thismaynotbesurprising ifoneconsiders thatduring197280 (aperiod

thatincludedbothoilshocks)theMUVincreasedby45percent,andthatduring

200008itincreasedbyonlyhalfasmuch.Theincreasesintheindexofnominal

nonenergypricesduringthesetwoeightyearperiodswereidentical,at170per

cent.

Lastly, theestimatesof trendparametersare spreadoverawider range

than theestimatesofenergypricepassthroughand inflation.Forexample, the

aggregate indexofnonenergypricesshowsno trendatall,while the indexofmetalpricesshowsanalmost2percentpositiveannual trendand the indexof

agriculturepricesshowsa1percentnegativeannualtrend.Further,thetrendpa

rameterestimatesoftheagriculturesubindicesvaryconsiderably,from0.08for

rawmaterials to 3.12 forbeveragesconfirming the pointmade earlier that

commoditypricesdonotexhibitwelldefined trends,evenwhenoneaccounts

fortheeffectofenergyprices.

4.ConcludingRemarks

Numerous factors have contributed to the recent commodityboom, and have

beenanalyzedextensivelyintheliterature.Yettheirrelativeweightcontinuesto

beanareaofcontention.Inthispaperweexaminedthreekeyfactorswhoserole

hasbeen somewhat controversial: speculation, thegrowthofdemand for food

commoditiesbyemergingeconomiesandtheroleofbiofuels.Weconjecturethat

indexfundactivity(onetypeofspeculativeactivityamongthemanythatthe

literaturerefersto)playedakeyroleduringthe2008pricespike.Biofuelsplayed

someroletoo,butmuchlessthaninitiallythought.Andwefindnoevidencethat

allegedstrongerdemandbyemergingeconomieshadanyeffectonworldprices.

Although tentative, theseconclusionsprovide insights into thedeterminantsof

thefuturepathofcommodityprices,whichisstilluncertain.

Centralamong theuncertainties is therelationshipbetween thepricesof

energyandof foodcommodities.Ourexaminationof thekeycharacteristicsof

longerterm commoditypricebehavior revealed a strong linkbetween energy

andnonenergyprices,whichincreasedconsiderablyduringtherecentboom;it

also revealed thatcomovementamong thepricesof foodcommodities isvery


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strong.The latter implies thatevents takingplace inone sector (e.g., increased

demandformaizefortheproductionofethanol)willaffectothermarkets(e.g.,

forwheat)throughreallocationofresources,especiallyland.Italsoimpliesthat

policy changes inonemarketmay affectothermarkets.Forexample, expecta

tionsabouttheuseofcornforbiofuelscouldresultinhighwheatpricesevenin

thepresenceofrecordlevelsofwheatstocks.Ourresultsalsoshowthatagricul

turalcommoditymarket fundamentalsappear, in theshort term, tobeplaying

somewhat less of a role than in thepast, tending tobe overshadowedby the

muchstrongerpullofenergyprices.

Ourconclusionaboutthelongtermevolutionofcommoditypricesiscon

sistentwithearlierliterature,andsupportsthethesisthatpricevariabilityover

whelmsprice trends.Variability issuch that theaveragepricedoesnotexistin

thestatisticalsense(i.e.,pricesexhibitnonstationarybehavior),andtheconclu

sionsreachedabouttrendsdependonwhattimeperiodischosenfortheanaly

sis.Despiteitssimplicity,thisconclusionhasimportantimplications.Follow

ingtherecentfoodpricespike,therehavebeencallsforpolicyactions,essential

ly aiming to alleviate the impacts of price spikes on developing countries,

throughrelianceonsomelevelofbufferstocks(whetherphysicalorvirtual).His

toryhasnotbeenkindtocollectivemeasuresdesignedtopreventthedeclineor

reducethevariabilityofprices.Whattypeofmeasureswouldbemorepertinent

tomitigateanyundesiredeffectsofpricevariabilitywoulddependonthebetter

understandingofthefactorsthatnotonlyaffect,butalsopotentiallyalter,long

termpricetrends.


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Endnotes1Numerousauthorshaveanalyzedtherecentcommodityboom.See,forexample,Abbott,Hurt,

andTyner(2008),Timmer(2008),Gilbert(2009),Mitchell(2009),PiesseandThirtle(2009),Sarris

(2009),Trostle(2008),andCoady,Dorosh,andMinten(2009).AgriculturalEconomicsdevotedan

entireissuetothesubject(MastersandShiverly2008).2See,forexample,VonBraunandTorero(2009)onvirtualreservesandMendoza(2009)onrice

insurancemechanisms.Todaysdiscussions call tomind those in earlierbooms (for example,

Meadowsandothers1972).

3Calvo (2008)andFrankel (2007)haveargued that interest ratesplayedakey roleduring the

boom.

4Althoughunderinvestmenthasbeencitedveryoftenasthekeyfactorintheboom,thisassess

mentisessentiallyderivedexpost.Certainly,anylevelofpastinvestmentwillbeconsideredlow

athighpricesandhighatlowprices.Yet,researchreportedinWorldBank(2009)showsthatthe

levelofinvestmentwasrightatthetimeitwasmade.Forexample,during19802007,R&Dand

investmentexpendituresbymajormultinationaloilandgascompaniestrackverycloselyoutput

prices (asevidencedby theirstrongcorrelationwithenergyprices,R2=0.95).Similarly,publicR&DagriculturalexpendituresfollowagriculturalGDP.

5ThisinverserelationshipisinadditiontotheeffectoftheUS$exchangerateagainstcurrencies

ofcommodityproducingandconsumingcountriesmentionedearlier.

6Informationonpensionand,especially,sovereignwealthfundsisnotwidelyavailable.There

centlypublishedfirstannualreportonsovereignwealthfundsisanattempttofillthisgap(SWF

2009).

7Yet,Verleger (2009:2)argued thatThecollapse inoilprices fromJuly2008 toDecember31,

2008canbetiedtothepossibleliquidationoffuturespositions.Whichbegsthequestion:If

the liquidationoffuturespositionswerepartlyresponsible forthecollapse inoilprices,should

notthetakingofsuchpositionsberesponsibleforthecorrespondingincreaseinoilprices?

8TheIOSCO(2009:3)reportsrecommendations,whichwerebasedonreviewingotherstudies,

were:(i)understandwithgreaterclaritytheroleofspeculativeandcommercialactivityincom

modity futuresmarkets; (ii) gain amore comprehensiveviewof trading activities in, and the

structureof,theunderlyingmarketsthatmayaffectpriceformationoncommodityfuturesmar

kets; and (iii) detect, deter, and prosecutemanipulation and other trading abuses involving

commodityfutures,andrelatedcommoditymarkets.

9See,forexample,Bykahin,Haigh,andRobe(2008)andCommodityFuturesTradingCom

mission(2008).

10Themodelsused in the studiesdiscussed in this section are the following:FAO (2008) and

OECD (2008) used AGLINK; Rosegrant (2008) used IMPACT; Banse and others (2008) used

GTAPE;EU (2008)usedESIMPE;Mitchell (2009)used simple statisticalanalysis;andGilbert

(2009)usedaCAPMtypeeconometricmodel.

11Suchfailedarrangements includethe1962InternationalCoffeeAgreement(andasubsequent

series of agreements) to restrict exports andboost coffee prices, the 1972 InternationalCocoa

Agreement,andsimilareffortsbyproducersofcottonandgrains; the InternationalTinAgree

ment;andtheInternationalNaturalRubberOrganization.Foradiscussionofsuchagreementsee

Gilbert(1996)andRadetzki(2009).


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12A largebodyof literaturediscussesthis issue;see forexample,Searchingerandothers(2008)

andFargioneandothers(2008).

13The lowenergypricesbetweenmid1980sandearly2000spromptedmostanalysts toargue

thatthehighpricesofthe1970swereanaberrationandthatthepre1973levelswerethenorm.

ForexampleinitsMarch6,1999edition,theEconomistsleaderarticleentitledDrowninginOilconcluded that (p. 19): $10might actuallybe too optimistic.Wemaybe heading forUS$ 5.

Thankstonewtechnologyandproductivitygains,youmightexpectthepriceofoil,likethatof

mostothercommodities,tofallslowlyovertheyears.JudgingbytheoilmarketinthepreOPEC

era, a normalmarket pricemight nowbe in theUS$ 510 range. Factor in the current slow

growthoftheworldeconomyandthenormalpricedropstothebottomofthatrange.Indeed,

most energy analystswere forecasting real prices to averagebetweenUS$ 15/barrel andUS$

20/barrelinthelongrun.Forexample,theWorldBanksnominalcrudeoilpriceforecastin1999

wasUS$18/barrelfor2005andUS$19/barrelfor2010.TheDecember2008WTIfuturescontract

openedatUS$18.88 inJanuary15,2002,when itwas first introduced.During2008, crudeoil

pricesaveragedUS$97/barrel,almostfivetimeshigherthanthehighestforecasts.

14Herethemodelisthesameastheoneusedaboveforcomovement,exceptthatPtidenotesthe

pricesoffoodcommoditiesandPtjdenotestheenergypriceindex.Therestofthecoefficientsand

variableshave the same interpretation.However, incontrast to thepricecomovement regres

sions, regressing foodprices on energypriceshas awelldefined endogeneitypattern; energy

affects foodpricesbutnotviceversa.Thus,weestimatedonly theregressionswith theenergy

priceindex(alongwithdeflatorandtimetrend)astheexplanatoryvariables.Theestimatescan

beviewedasenergypricetransmissionelasticitiesratherthanjustcointegrationparameters.See

Baffes(2009)forthestructureoftheindices.

15Table7indicatesthattheelasticitiesforfoodcommoditiesarehigherthanthoseforrawmate

rials andmetals. This is consistentwith the inputoutput table of theGTAPdatabase,which

shows that thedirectenergycomponent in theUSagricultureandmanufacturing sectors is12

percentand3percentrespectively.


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TABLE1

ANNUALGROWTH(PERCENT)INGLOBALGDP,POPULATION,

ANDCONSUMPTIONFORSELECTEDCOMMODITIES

196172 197384 198596 19972008

MACRO

VARIABLES

Population 2.0 1.8 1.6 1.3

GDP,real 5.5 3.4 2.8 3.0

CONSUMPTION

Rice 3.3 2.7 1.9 1.2

Wheat 3.9 2.9 1.4 0.9

Maize 3.7 2.5 2.7 2.8

Soybeans 4.8 2.6 5.5 4.0

PalmOil 8.4 10.2 7.7 8.8

Beef 3.2 1.8 1.1 1.0

Pork 3.7 4.9 2.7 2.2

Poultry 12.1 6.9 6.8 4.0

Source:AuthorscalculationsbasedonFAO,FAPRI,WorldBank,andUNdata.

TABLE2

ANNUALGROWTH(PERCENT)INCONSUMPTIONOFSELECTEDCOMMODITIES

WORLD CHINA INDIA

19972002 200308 19972002 200308 19972002 200308

GDP 2.9 3.3 8.4 10.4 5.1 8.5

Wheat 1.3 2.7 0.7 0.2 2.7 1.8

Rice 1.6 1.5 0.5 0.6 1.0 1.9

Maize 1.8 3.6 2.8 3.4 1.9 5.5

Soybeans 5.8 3.3 16.1 8.7 1.4 7.1

PalmOil 10.5 7.5 22.1 8.2 21.4 7.2

Beef 0.8 1.6 3.8 2.8 0.5 2.2

Pork 2.7 1.3 2.8 1.2 1.0 0.4

Poultry 4.7 3.8 4.9 4.6 17.6 7.7

Source:AuthorscalculationsbasedonFAO,FAPRI,WorldBank,andUNdata.


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TABLE3

KEYBIOFUELSTATISTICS

200001 200203 200405 200607 200809

Biofuelsasashareofglobalgrainandoilseedarea(percent)

EUoilseeds 0.00 0.06 0.15 0.24 0.34USmaize 0.13 0.27 0.37 0.76 1.11

LandusedforUSethanolfrommaizeasashareof(percent)

USMaizearea 3.63 7.32 9.45 18.03 27.54

USGrainarea 0.99 2.00 2.79 5.68 8.44

Worldgrainarea 0.16 0.32 0.43 0.85 1.26

Notes:Theshareshavebeencalculatedbasedonaverageworldyields.

TABLE

4

STATIONARITYSTATISTICSFORKEYFOODCOMMODITYPRICES,19602008

WithoutTrend WithTrend

ADF PP ADF PP

REAL(MUVDeflated)SERIES

Wheat 2.32 1.70 1.83 1.47

Maize 1.59 1.49 1.84 1.83

Rice 1.59 1.71 3.08 1.92

Soybeans 1.72 1.59 2.09 1.96

Soybeanoil 1.34 2.06 0.96 2.28

Palmoil 1.41 2.14 1.31 2.47

NOMINALSERIES

Wheat 1.63 0.84 3.10 2.02

Maize 1.69 1.22 2.76 2.21

Rice 2.53 1.62 3.40* 2.27

Soybeans 1.32 1.23 2.11 2.14

Soybeanoil 1.08 1.17 1.99 2.56

Palmoil 1.41 2.14 1.31 2.47

Notes:ADFandPPdenotetheAugmentedDickeyFuller(DickeyandFuller1979)andPhillips

Perron (Phillips andPerron, 1988) statistics forunit roots.Asterisks in this and the following

tablesdenotesignificanceat10%(*),5%(**),and1%(***)levels.Thecorrespondingtstatisticsare

2.60, 2.93,and 3.58forthetestswithouttrendand 3.18, 3.50,and 4.16forthetestswithtrend.

TheADF statisticcorresponds to theMacKinnononesidedpvalue.The lag lengthof theADF

equationswasdeterminedbyminimizingtheSchwarzlossfunctionwhilethebandwidthofthe

PPstatisticwasbasedontheNeweyWestmethod.


26/42

Page24

TABLE5

PARAMETERESTIMATES:COMOVEMENTREGRESSIONS

1 2 100* 3 AdjR2 ADF

MaizeWheat 0.29

(1.37)

0.85@

(14.40)

0.06

(0.77)

0.33

(1.35)

0.94 4.86***

SoybeansWheat 0.90@

(3.20)

0.78@

(10.21)

0.19@

(1.99)

0.45

(1.40)

0.92 5.20***

WheatRice 0.34

(1.01)

0.60@

(8.31)

0.26@

(2.36)

0.41

(1.02)

0.90 4.54***

SoyoilWheat 1.75@

(3.90)

0.97@

(7.83)

0.08

(0.51)

0.03

(0.05)

0.81 6.54***

WheatPalmoil 0.02

(0.02)

0.63@

(6.64)

0.39@

(3.26)

0.04

(0.10)

0.87 5.30***

MaizeSoybeans 0.16

(0.54)

0.85@

(10.82)

0.04

(0.39)

0.01

(0.92)

0.91 6.18***

RiceMaize 0.48

(0.99)

1.02@

(7.24)

0.13

(0.81)

0.86

(1.54)

0.77 5.60***

PalmoilMaize 1.27@

(2.69)

1.09@

(8.00)

0.04

(0.27)

0.17

(0.31)

0.79 5.64***

SoyoilMaize 1.45@

(3.64)

1.12@

(9.72)

0.13

(0.98)

0.39

(0.86)

0.86 6.90***

RiceSoybeans 0.00

(0.01)

1.01@

(7.13)

0.06

(0.32)

0.79

(1.41)

0.76 5.19***

SoybeansPalmoil 0.54

(1.48)

0.53@

(7.75)

0.41

(3.96)

0.35

(0.91)

0.89 4.54***

SoyoilSoybeans 0.89@

(2.09)

1.12@

(9.82)

0.23

(1.61)

0.47

(1.04)

0.86 7.73***

PalmoilRice 1.70@

(1.48)

0.64@

(5.40)

0.18

(1.01)

0.01

(0.02)

0.69 5.15***

SoyoilRice 1.94@

(3.71)

0.64@

(5.80)

0.12

(0.53)

0.71

(0.86)

0.74 5.71***

PalmoilSoyoil 0.13

(0.44)

0.97@

(16.83)

0.08

(1.03)

0.54@

(1.79)

0.93 4.32***

Notes:Allregressionswereruninbothdirections.(@)denotesparameterestimatesignificantatthe 5percent level.We report thedirectionwith the largestADF statistic.Thevarianceshave

beenestimatedusingWhitesmethodforheteroskedasticityconsistentstandarderrors.Forother

notesseetable4.


27/42

Page25

TABLE6

PARAMETERESTIMATES:PRICEINDICESREGRESSEDONENERGYPRICEINDEX

1 2 100* 3 AdjR2 ADF

NonEnergy 3.03@

(6.54)

0.28@

(5.24)

0.12

(0.68)

0.01

(0.02)

0.90 3.35**

Metals 3.77@

(4.80)

0.25@

(3.14)

0.17

(0.60)

1.93@

(2.31)

0.82 3.30**

Fertilizers 3.58@

(4.12)

0.55@

(4.79)

0.30

(0.95)

0.39

(0.48)

0.81 3.97***

Agriculture 2.51@

(6.90)

0.26@

(5.54)

0.33@

(2.43)

0.99@

(2.73)

0.90 3.81***

Beverages 1.83@

(3.10)

0.38@

(4.87)

0.55@

(2.63)

3.12@

(5.22)

0.76 4.95***

Rawmaterials 1.85@

(4.16)

0.11@

(2.15)

0.51@

(3.15)

0.08

(0.19)

0.91 3.15**

Food 2.91@

(7.11)

0.27@

(4.93)

0.21

(1.39)

0.71

(1.80)

0.85 3.85***

Cereals 3.13@

(5.94)

0.28@

(4.23)

0.17

(0.89)

0.87

(1.76)

0.78 3.83***

Edibleoils 3.33@

(6.16)

0.29@

(4.51)

0.12

(0.58)

0.80

(1.50)

0.80 2.82*

Otherfood 1.86@

(6.28)

0.22@

(3.81)

0.45@

(4.44)

0.42

(1.18)

0.89 3.60***

Preciousmetals 1.40@

(3.58)

0.46@

(9.40)

1.05@

(7.61)

1.75@

(3.68)

0.98 3.91***

Notes:SeeTables4and5.

Source:Baffes(2009).


28/42

Page26

TABLE7

COMPARINGLONGRUNTRANSMISSIONELASTICITIES

Holtham

(1988)

1967:S1

1984:S2

Gilbert(1989)

1965:Q1

1986:Q2

Borensztein&

Reinhart(1994)

1970:Q1

1992:Q3

Baffes(2007)

19602005

Baffes(2009)

19602008

Nonenergy 0.12 0.11 0.16 0.28

Food 0.25 0.18 0.27

Rawmaterials 0.08 0.04 0.11

Metals 0.17 0.11 0.11 0.25

Notes:Holthamusessemiannualdata,GilbertandBorensztein&Reinhartquarterly,andBaffes

alongwiththepresentstudyannual.Gilbertselasticitiesdenoteaveragesbasedoffourspecifica

tions.Holthams rawmaterialselasticity isanaverageof two elasticitiesbasedon two setsof

weights.indicatesthattheestimateisnotavailable.

Source:Holtham(1988),Gilbert(1989),BorenszteinandReinhart(1994),Baffes(2007,2009).

TABLE8

PARAMETERESTIMATES:INDIVIDUALCOMMODITIESONENERGYPRICEINDEX

1 2 100* 3 AdjR2 ADF

Wheat 3.27@

(6.50)

0.30@

(5.02)

0.12

(1.49)

0.49

(1.07)

0.84 4.35**

Maize 3.15@

(6.23)

0.27@

(4.66)

0.13

(0.70)

0.74

(1.58)

0.80 3.49**

Soybeans 3.58@

(8.11)

0.26@

(4.92)

0.25

(1.51)

0.82

(1.83)

0.82 3.85***

Rice 3.57@

(5.14)

0.25@

(2.67)

0.32

(0.26)

1.62@

(2.78)

0.58 4.05***

Palmoil 4.94@

(6.44)

0.35@

(3.72)

0.01

(0.02)

0.95

(1.38)

0.63 3.16**

Soybeanoil 5.25@

(7.83)

0.36@

(4.13)

0.09

(0.39)

0.42

(0.53)

0.70 2.56

Notes:Seetables4and5.


29/42

Page27

Figure1

CommodityPriceIndices(Real,MUVdeflated,2000=100)

Figure2

RealGDPGrowth(AnnualPercentChange)

1

0

50

100

150

200

250

300

350

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008

Agriculture

Source:WorldBank

Korean

war

Oil

shocks

Recent

boom

4

2

0

2

4

6

8

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Developingcountries

Source: World Bank


30/42

Page28

Figure3

GlobalGrainStockstoUseRation(Percent)

Figure4

CommodityPriceIndices(Nominal,2000=100)

3

10%

15%

20%

25%

30%

35%

40%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

IncludingChina

Source:USDepartmentofAgriculture

4

100

200

300

400

500

Jan04 Jan05 Jan06 Jan07 Jan08 Jan09 Jan10

Agriculture

Source:WorldBank


31/42


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APPENDIXA.WHATISSPECULATION?

Blaming speculative activity inperiods of sharpprice increases isnotuncom

mon.Pushedbysuchabelief,numerousattemptshavebeenmadetorestrictor

evenclosetheUSfuturesmarkets.Markham(1987)reportsthatduring190709

(60thUSCongress),25billswereintroduced,designedtoprohibitfuturestradingforacomprehensive treatmentofallattempts to regulateand/orprohibit

futures trading seeCowing (1965).BaffesandKaltsas (2004)describehownu

merouscottonfuturesexchangeswereshutdownduringthefirsthalfofthe20th

century as the result of government intervention, againbecause of perceived

speculativeactivity.Schaede (1989)documents similarattempts for theDjima

ricemarketinJapan,oftencitedastheworldsoldestfuturesexchangeitbegan

operationin1730.

Whatmakestherecentdebateonspeculationinterestingisthatithasdi

vided even noted scholars and analysts.Apart from the insufficient empiricalevidenceonthesubject,suchdivisionpartlyreflectsthedifferenttypesofspe

culativeactivitythatanalystsandeconomistsreferto.Indeed,thelinesbetween

hedgersandspeculators,betweenphysicalandfinancialtransactions,aswellas

between legaland illegal tradingactivitiesarecomplex,blurry,andgobeyond

textbookdefinitions.Togaugesuchcomplexities,considerthetraditionalsepa

rationoftheplaceinwhichtransactionstakeplace(physicalversusfinancial)and

theactorsinvolved(hedgersversusspeculators),asdepictedintableA1.Thefirst

columnshowshedgingtransactionsbyproducers,consumers,andtraders(with

thebanksas intermediaries) that takeplaceeither inphysicalor financialmar

kets (the latter in commodity futures exchanges).This is the typical textbook

case. The picturebecomes complicated, however,when speculators engage in

physicaltransactionsbyholdinginventories,keepingresourcesintheground,or

engaging in various types ofmarketmanipulation. Amore complex picture

emergeswhenspeculatorsengageinfinancialtransactions(oftencombinedwith

physicaltransactions).

Hence, understanding the complexities and the controversial nature of

speculationultimatelycomesdowntounderstandingtherightbottomcellofthe

TableA1.Onewaytoanalyzespeculationistomapitssourcesanditseffecton

commoditymarkets to the placewhere transactions take place, the actors involved,andtheirmotivation.

Placeoftransaction

Commoditytransactionstakeplaceeitherinfuturesexchangesorphysicalmar

kets.Speculation takingplace in commodity exchanges forms thebackboneof

the functioning of the futuresmarketsby injecting the necessary liquidity to


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Page37

complete the transactions.This is the typeofspeculativeactivity thatwas typi

cally given as a reason for the closure of commodity futures exchangesmen

tionedabove.

Inthephysicalmarket,ontheotherhand,tradersmaybuyandholdlarge

quantities of commoditieswith the expectation that an upwardmovement in

priceswillgenerateprofits(oftencalledhoarding).Thisisthetypeofspeculative

activity thatPaulKrugman andMartinWolf (among others)have referred to.

Unlesssuchactivityentailsmarketmanipulation (inwhichcase itwouldbean

illegal activity), it is the intertemporal equivalent ofAdam Smiths invisible

hand:tradersbuyatcurrentpricestoselllaterwhen(intheiropinion)themar

ketwillbetight,therebybalancingthemarketandhencereducingpricevariabil

ity.There isno evidence thathoarding tookplaceduring the recentboom, as

knowninventoriesinalmostallcommoditiesreachedhistoricallows.However,

inthecaseofextractivecommoditiesespeciallycrudeoilonemaywellargue

thattargetingoutputtolevelsbelowwhatthemarketfundamentalsdictate(asis thecasewithOPECquotas) isa formofhoarding.Thedifference is that the

commodityiskeptintheground,ratherthaninabovegroundandthereforeoff

themarketstoragefacilities.

Actorsinvolved

Apart from the hedgers (e.g., producers and consumers)with interest in the

physicaltransactionofcommodities,twootheractorshavebeenoperatinginthe

marketduringthelasttwoorsodecadeswithpurelyfinancialincentivesandno

transactionsinthephysicalmarkets.Theyarehedgefundsandcommoditytrading advisors (CTAs). During the past few years, investment funds (mostly

pensionfundsandsovereignwealthfunds)alsoenteredthefinancialmarkets.It

hasbeen argued that thesegroups (mostly the latter)mayhave affected com

modityprices.

Hedgefunds.Theseundertake investmentandtradingactivities inabroadrangeofassets, includingcommoditymarkets.Ahedge fundmay tradeand invest incom

modityassetclassesinordertohedgethediverserisksinherentintheirportfolios.

Insuchacase,takingapositioninthefuturesmarketforaparticularcommodityor

commodityclasscanrepresentaninvestmentinanoncorrelatedassetthatprovides

diversificationbenefitstotheoverallportfolio.Hedgefundshaveexistedfordecadesandtheireffectoncommoditymarketsistypicallyofshorttermnature(i.e.,theyaf

fectshorttermpricemovements).

Commoditytradingadvisors(CTAs)areassetmanagersthatoperatealmostexclusivelyincommoditymarkets.Theyinvestforportfoliosundermanagementandforclients

with theobjectiveof earningprofits frommarketvolatility.Perhaps,CTA activity

reducespricevolatility since they tradeon thebasis ofmarket fundamentals and


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technicalanalysis.

Investmentfunds.Theyincludesovereignwealthandpensionfundswhichduringthepastfewyearsbegan includingcommoditiesintheirportfoliomixasanotherasset

class.Their chiefmotivationhasbeenassetdiversification. Inaddition to theway

thesefundsinvestinfuturesmarkets(i.e.,fixedweightsandpastperformancecrite

ria),itistheirsheersizethatmattersmost(seediscussioninmaintext).

Motivation

Veryoftenspeculationtakesplaceintheformofmarketmanipulation.Thisre

ferstoillegalactivitytypicallyisolatedinoneorafewcommoditymarkets.Itcan

takeplaceinthephysicalorfinancialmarkets(oftenitinvolvesboth).Wellpub

licizedcasesare theUSonionmarket in the1950s,whereonionproducersar

guedthattradersintheChicagoMercantileExchangecorneredthemarket(this

resulted in thepassageof theOnionsFuturesActwhichprohibitedfuturescon

tractsononions);theHuntbrotherswhoattemptedtocornerthesilvermarketinthelate1970sandearly1980s;Sumitomoschiefcoppertrader,YasuoHamana

ka,whocornered thecoppermarket in the1990s;and theBPcorneringof the

propanemarketin2006,whichresultedinaUS$300millionfine.Suchactivityis

notknowntohaveprevailedduringtherecentboom.

TABLEA1:SPECULATIONINCOMMODITYMARKETS

ACTOR

PLACEHEDGERS SPECULATORS

PHYSICAL

Producers/consumers Traders Banks

Holdinginventories(e.g.,hoarding) Keepingresourcesintheground(e.g.,OPEC) Marketmanipulation(e.g.,corneringthemarket)

FINANCIAL

Producers/consumers Traders Banks

Investmentfunds(e.g.,pensionfunds,sovereignwealthfunds)

Investmentanddiversificationinstruments(e.g.,CTAs,hedgefunds)

Marketmanipulation(e.g.,corneringthemarket)


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APPENDIXB.COMOVEMENTOFCOMMODITYPRICES

Thegeneralsubjectofcommoditypricecomovementhasbeenexaminedexten

sivelyandinvariouscontexts.Yetsometopicshavereceivedmuchmoreatten

tionthanothers.Thetopicsthathavereceived lessattentionmattermostinthe

currentpolicydebate.Overall,theresearchoncommoditypricecomovementfallslargelywith

intwostrands.Thefirstexaminescomovementamongpricesofthesamecom

modityindifferentlocationswithinthemarketefficiencycontext,aphenomenon

alsoknownasspatialmarketintegrationorthelawofoneprice.Whilemostof

thesestudiesexaminecomovementinabivariatecontext,someusemodelsca

pableofexamining itwithinamultivariatesetting.This topichasbeenstudied

extensively (seeFackler andGoodwin 2001 for a literature review).A less re

searched subject (thoughonemoreuseful forpolicy analysispurposes)within

thatstrandhasbeenthecomovementbetweenworldanddomesticcommodityprices,arelationshipthatincludesapolicydimension.Specifically,thesestudies

examinewhetherworldprice signals havebeen fully transmitted todomestic

marketsor insteadhavebeen subjected topolicydistortions (see, forexample,

Baffes and Gardner 2003;Mundlak and Larson 1992). Now, for agricultural

products, a research project ledbyKymAnderson hasproduced a consistent

globaldatabasethatincludespricesreceivedbyfarmersandpaidbyconsumers

in75countries(Andersonandothers2008).Thatdatabaseisexpectedtogenerate

moreresearchonthesubject.

Thesecondstrandofliteratureexaminespricecomovement(orlackthe

reof) amongdifferent commodities.Thegenesis of this literature goesback to

Granger(1986:218),whowrote:Ifxtandytareapairofpricesfromajointlyef

ficient,speculativemarket,theycannotbecointegratedifthetwopriceswere

cointegrated,onecanbeusedtohelpforecasttheotherandthiswouldcontra

dicttheefficientmarketassumption.Thus,forexample,goldandsilverprices,if

generatedbyanefficientmarket,cannotmovecloselytogetherinthelongrun.

Grangersassertionledtoresearchincommoditymarkets(e.g.,MacDonaldand

Taylor1988)andothermarketsaswell,notablyexchangerates(see,amongoth

ers,BaillieandBollerslev1989;HakkioandRush1989).Thisresearchwas later

questionedonseveralgroundsincludingthefactthatcomovementreflectsresponses tocommon fundamentalsrather thanmarket inefficiencies. (See, forex

ample,Agbeyebbe1992;Baffes1993;DwyerandWallace1992;andSephtonand

Larsen1991.)

Asimilarlycontroversialsubjecthasbeen theexcesscomovementhy

pothesis firstdiscussedbyPindyckandRotemberg (1990)who,afteranalyzing

pricemovementsofsevenseeminglyunrelatedcommodities(cocoa,copper,cot


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