Slowing the rollercoaster

The wild fluctuations in prices of traded commodities and resulting movements in currencies in the past week almost feel like they are par for the course in the turbulent world of 2011.

There are a lot of analysts reading the charts and screens in these markets saying that pretty soon the heated-up bubble driven by the appetite of China for food and other resources is about to burst. Last week’s massive sell-off of oil, precious metals and other resources also sent currency markets into a spin and sliced a few cents off our over-valued dollar, which is badly needed for food exporters.

The interesting question is what has been driving these recent changes?

Speculation into asset values and related financial instruments which created massive false economies drove the world into a global crisis in 2008. Three years later, the same people are mostly at the same screens. It is hardly a surprise that the majority of the action in the day-to-day prices of a raft of agricultural, oil and metal commodities is caused by the actions of speculators. Last week’s big shifts have been blamed on the actions of US regulators watching commodity exchanges such as the CME in Chicago trying to curb the behaviour of investment funds taking speculative “long” positions.

It seems ironic. Risk management tools were originally created to help people engaged in physical delivery of products to manage their exposures by covering positions and creating more operating certainty. These same tools provide opportunity for others with much larger sums of money at their disposal to trade on information – any information at all.

Complaint about the actions of speculators is hardly news. Farmers, food companies and consumer advocates have complained for a century about the effects of excessive speculation. US regulators presently restrict speculators in many agricultural and other commodities that affect farmgate prices and input costs in Australia. The regulators of US commodity exchanges have now moved to increase the “margin” requirements for participants, inferring that prices have been driven higher and made more volatile because the scope exists for growing amounts of money to play the markets. With interest rates being so low in the world, larger funds have diverted more of their funds into instruments that offer scope for gains through speculation.

Those watching these markets may be premature in thinking that by squeezing the practices of speculators we can slow things down a bit and have prices more reflective of the underlying fundamentals. Thinking this might be a remedy ignores the underlying issue that there is increasing volatility because the world is trading most of these commodities with fairly thin levels of inventory or uncommitted supply. Demand and global turbulence – weather and political – has created scarcity. The fundamentals themselves are more complex, with a longer list of influential variables.

Nonetheless there will be attempts to close down the scope for volatility in the US. In reality they’ll take years to sort this out in that country, an engine room of speculation and financial greed, between the vested interests across politicians, regulators and financial institutions. Fixing the US health system is probably a useful analogy – there might be different players such as such as doctors and insurers involved, but the vested interests are just as big.

In the meantime, enjoy the rollercoaster!