Response to Randy Wray’s Biggest Commodity Bubble of All Time

L. Randall: You present a compelling argument for a commodity bubble.

Yes, the financialization of commodities has truly played a role in rising global commodity prices via the many new ETPs (exchange traded products) backed by either commodity futures or physicals, as well as indices and other forms of investible instruments. Yet I wish to point out a three specific flaws to your argument.

1) Many commodities, whose prices not only have risen over the decades but have shown large swings in volatility, are not exchange-traded. In the case of many fruits and vegetables, financial speculation was not the cause of high prices. Mediterranean countries saw rapid escalation in the price of tomatoes in the last few years, while Latin American nations experienced a tripling of bean prices within months. No tomato or chili bean futures contracts exist to date. On numerous occasions, these and other commodity prices rose faster than those of exchange traded commodities due to such factors as low yields, poor crop numbers and bad harvests as well as hording by governments in times of scarcity or domestic inflation. Today, 17 different rare earth metals are the focus and are largely not exchange traded; yet their prices continue to surge higher as a result of trade restrictions, not financial speculation.

2) Your comment, (as related to pension funds buying commodities through futures contracts)

…”If prices rise, you always win on the roll (sell for more than you paid)”…

… is incorrect. One only profits from this method of futures trading when the term structure (forward curve) is in backwardation, meaning, today’s prices are higher than futures prices. In fact many commodity term structures are in contango (positively sloping yield curve) which makes this roll trade a losing proposition i.e. you sell for less than what you paid. As such, one can lose money in futures trading even when spot prices are rising.

3) Finally, the real bubbles we have experienced in the last decade – housing and tech stocks – were highly country and region specific. Commodities, on the other hand, are global in nature, and consumed by everyone. And the size of “everyone”, in numbers, has increased, to the tune of three billion new customers over the last three decades as China and India moved to market economies. That means more industrialization, infrastructure, housing, roads, cars and mouths to feed in a world limited by such inputs as land, water, fossil fuels and ore grades. In such a scenario, higher prices are inevitable.

Thank you.

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