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PROLOGUE
COMMENTRY EXPERTS' VIEWS INDIAN ECONOMY
ECENOMY

Inside...

Commodity price movements:
Understanding causes and consequences
John Baffes >> 14

Business cycles and their relationship with
the commodity economy
Stephan Pfaffenzeller >> 18

Can the commodity economy be decoupled
from the financial sector?
Adam Gross >> 22

Recent trends in global commodity prices
and regulatory responses: Which way now?
Partha Ray >> 28

Commodity cycles :
Follow or cause economic cycles
Robin Roy and Sanjoy Majumder>> 36

China©s pre-eminence in the
global gold market
Jeffrey M. Christian >> 40

Re-writing the rules of the game:
Evolving contours of global
regulatory regimes to govern
derivatives
Michael Greenberger and Michael Vesely >> 44

Market as a ªbail-outº institution: Commodity
exchanges in liberalised trade regime
Nilanjan Ghosh >> 50

12 Commodity Insights Yearbook 2011

012-053_CIYB_2011_Exper's Views.indd 12 1/26/2012 1:38:36 AM

DATABANK - NON-AGRI COMMODITIES DATABANK
DATABANK- -AGRI
AGRICOMMODITIES
COMMODITY

EXPERTS’ VIEWS
The upheaval witnessed in the world economy over the past three years
has left its indelible mark, probably for all times to come, on the way
markets are viewed and studied. In the following pages, ten experts try to
decipher and put forth their insights into and perspectives on the message
that this seemingly unending upheaval carries, particularly, in the context
of the global commodities market.

Even if it were to be shown that unfavourable impacts existed, the
challenge is to calibrate a response that eliminates the price distortion
and volatility exacerbation effects without adversely affecting market
liquidity, and without deterring the participation of arbitrageurs and
those speculators whose participation brings valuable new information
into the market's price formation process.
Adam Gross, Director of Strategy ± Bourse Africa

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PROLOGUE
EDITORIALS EXPERTS' VIEWS
EXPERTS' VIEWS INDIAN ECONOMY

Commodity price movements:
Understanding causes
and consequences
By John Baffes, Senior Economist, World Bank

The commodity price boom witnessed since early 2005 has been one of the longest
and broadest, post-World War II. This essay concludes that a number of factors formed
what has often been called the `perfect storm'. Some of these factors have more of
a permanent character implying that commodity prices are not only likely to stay
elevated but may also become more volatile.

and likely consequences of the boom. It concludes that
a number of factors formed what has often been called
the “perfect storm” and that prices are not only likely to
stay elevated but may also become more volatile.

The nature and causes of the boom
The recent commodity boom emerged in the mid-2000s
after nearly three decades of low and declining commodity
prices (see chart 1). The long-term decline in real prices
had been especially marked in food and agriculture.
Between 1975-76 and 2000-01, world food prices fell
by more than 50 per cent in real USD terms. Such price
declines raised concerns, especially with regard to the
welfare of low-income agricultural producers. In fact,
one of the Doha Round’s chief motives (and also one
of its perceived main obstacles) was the reduction of
agricultural support and trade barriers in high-income
countries—a set of reforms that was expected to induce
increases in commodity prices and, thus, improve
the welfare of poor commodity producers (Aksoy and
Beghin 2005, Anderson and Masters 2009). Starting
in the mid-2000s, however, prices of most commod-

T
ities reversed their downtrend, eventually leading to an
he commodity price boom that began in early unprecedented commodity price boom.
2005 has been one of the longest and broadest The recent boom shares two similarities with the
post-Second World War (World Bank 2009). In two earlier major commodity booms of the post-WWII
2008, crude oil prices peaked at US $147 a period, during the Korean War and the early 1970s
barrel (up over 94 per cent from a year earlier) while rice energy crisis (Radetzki 2006, and Baffes and
prices doubled within just five months. Cotton prices Haniotis 2010).
almost tripled in six months in early 2011, while gold Each of the three booms took place in an environment
temporarily exceeded $1,900 an ounce in late August conducive to high prices including high and sustained
2011. The boom has renewed interest in the long-term economic growth as well as an expansionary macroeco-
behaviour and determinants of commodity prices, and nomic environment, and each was followed by a severe
raised questions about whether prices have reversed slowdown of economic activity. And, all three triggered
the downtrend most of them followed during most of discussions on coordinated policy actions to address
the past century. This essay summarizes the causes food and energy security concerns.

14 Commodity Insights Yearbook 2011

012-053_CIYB_2011_Exper's Views.indd 14 1/26/2012 1:39:12 AM

DATABANK - NON-AGRI COMMODITIES DATABANK - AGRI COMMODITIES

Yet the recent boom also exhibits some important Table 1: The `perfect storm'
differences from the previous ones. By most accounts,
2001-05 2006-10 Change
it is the longest lasting and broadest in the number of
Crude oil price (US$/barreal, nominal) 33 75 127%
commodities involved. It is the only one that simultane-
Exchange rates (US$ against a broad index of currencies) 119 104 -13%
ously involves all three main commodity groups—energy,
metals, and agriculture—with its peak showing food Interest rates (10-year US Treasury bill) 4.7 4.1 -14%

and agriculture prices increasing less than the other Funds invested in commodities ($ billion) 30 250 730%
two indices. It was not associated with high inflation, GDP growth, low and middle income countries (% p.a.) 5 5.8 16%
unlike the boom of the 1970s (although the increase in Industrial production, low and middle income countries (% p.a.) 6.3 7.1 13%
food prices had some notable, albeit short-lived, impact Stocks of maize, wheat, and rice (months of consumption) 3.2 2.5 -21%
on inflation). Finally, it unfolded simultaneously with Biofuel production (million of barrels per day equivalent) 0.4 1.3 203%
the development of two other booms—in real estate Yields (average of wheat, maize, and rice, tons/hectare) 3.8 4 7%
and equity markets—whose end led most developed Growth in yields (% change per annum, average) 1.4 1 -32%
countries to their most severe post-WWII recession.
Natural disasters (droughts, floods, and extreme temperatures) 374 441 18%
The recent boom took place in a period when most
countries, especially developing ones, sustained strong Source: World Bank, IMF, FRED, USDA, CRED, IEA, and author's calculations
economic growth. During 2003-2007, growth in devel-
oping countries averaged 6.9 per cent, the highest reached, or moved close to, 2008 levels (see chart 2).
five-year average in recent history. Yet apart from broad The 2010/11 resurgence reaffirms that some of the
and prolonged economic growth, the causes of the recent factors behind the boom have a permanent character,
boom were numerous, including macro and long-term as implying that not only prices are likely to stay elevated
well as sector-specific and short-term factors. compared to recent historical levels but may also be
Fiscal expansion in many countries and lax subjected to higher variability.
monetary policy created an environment that favoured
high commodity prices. The depreciation of the US The way forward
dollar—the currency of choice for most international
commodity transactions—strengthened demand (and Chart 1: Long-term price trends: 1948-2010
(Real, MUV-deflated, 2000=100)
limited supply) from non-USD commodity consumers
350
(and producers). Other important contributing factors Korean
War
Twooil
crisis
Recent
boom

include low past investment, especially in extractive 300

commodities (in turn a response to a prolonged period 250
of low prices); investment fund activity by financial Agriculture
200
institutions that chose to include commodities in their
portfolios; and geopolitical concerns, especially in 150
Metals
energy markets. 100

In the case of agricultural commodities, prices were
50
Energy
affected by higher energy prices (energy is a key input
0
to most agricultural commodities), more frequent than 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008
usual adverse weather conditions, and the diversion of
some food commodities to the production of biofuels Source: Worldbank

(notably maize in the US and edible oils in Europe).
These conditions pushed global stock-to-use ratios of The key question is which of the factors behind the
several agricultural commodities down to levels not boom are more permanent in nature. A considerable
seen since the early 1970s, further accelerating the part of the agricultural commodity price movements can
price increases. Policy responses including export bans be explained by changes in energy prices. Consider,
and prohibitive taxes (especially in the rice market) for example, that during 1986-2003 the nominal
that were introduced in 2008 to offset the impact of energy index averaged 72 and increased to 224 during
increasing world food prices contributed to creating 2004-2009 — up by 213 per cent. The agricultural
the conditions for the “perfect storm” (see table 1 for price index increased by 43 per cent during the two
numerous summary statistics). periods (from 119 to 170), identical to what a 0.20
The weakening and/or reversal of these factors, transmission elasticity would imply when applied
coupled with the financial crisis that erupted in to the energy price increase (0.20*2.17 = 0.43).
September 2008 and the subsequent global economic Although, such calculation is very simplistic since it
downturn, induced sharp price declines across most masks considerable price variation within sub-periods,
commodity sectors. However, prices picked up again in in addition to being supported by strong econometric
2010 and by mid-2011 prices of most commodities had evidence (Baffes 2007 and 2011), it is consistent with

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A PwC & MCX Joint Endeavour 15

012-053_CIYB_2011_Exper's Views.indd 15 1/26/2012 1:39:22 AM

has increased. Indeed. April 7. has been hotly debated. As chart 4 that “… as countries like China and India prosper and shows. India. especially the price k Turkey 0 3 6 9 12 15 18 spike of 2007/08. including China and India.e. which together account for 27 per cent of the world’s population.” 0 70 0. Alexandratos (2008:673) 1. However. Krugman argued that “… level (i. pointing to an emerging new and Manufacture Agriculture WORLD fixed relationship between them. of extractive commodities has been discussed often in Thus. But how much was Canada EUͲ12 the impact. noted driver of the increases in metals prices. perhaps. the growing number of people in emerging economies Chart 2: Short term price movements: Jan 2004 .” Similar arguments have been advanced tively reversed the metal intensity of GDP at a global by noted scholars as well. Gilbert (2010). the amount of metal consumed to produce a there’s the march of the meat-eating Chinese—that is. growth grain by emerging countries. the empirical Chart 3: Commodity intensities of GDP: 1971-2010 evidence points to the contrary conclusion that food (commodity use per unit of GDP) consumption by China and India did not increase during 1. has their people move up the food ladder. maize and HIGHINCOME DEVELOPING its use for ethanol moved into the picture as significant SSA US factors affecting price developments. it excludes livestock). The June been very strong. version 8. for example.indd 16 1/26/2012 1:39:26 AM . 2008). 16 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. the size of China and 200 India.90 (both growth rate and absolute increments) was lower in the years of the price surges (2002-2008) than the 0.80 preceding period 1995-2001. in developing countries (where most of the growth in and especially during the past decade when these two demand for commodities has been taking place) has countries experienced high-income growth. on the other hand. metal consumption. Mitchell (2009) argued that biofuel production from grains and Source: GTAP preliminary release 0. unit of GDP). 2000 = 100) like Westerners” (New York Times editorial.00 emphatically stated: “… their (China’s and India’s) combined average annual increment in consumption 0. oilseeds in the US and the EU was the most important Note: Agriculture refers to crops (i.e. the price increase. Indeed. rich enough to start eating (US$ nominal price indices. agriculture is 4-5 times role in energy markets as well (the effect of demand more energy-intensive than manufacture (see chart 4). 300 notably meat and the related animal feeds” (Financial Times. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY the fact that agriculture is an energy-intensive industry. implies that even a minor change 100 JanͲ04 JanͲ05 JanͲ06 JanͲ07 JanͲ08 JanͲ09 JanͲ10 JanͲ11 in their pattern of demand growth has a major effect on Source: Worldbank world market prices. maize and crude oil prices (cost of energy component measured in 2007. Wolf asked “So why have prices of food risen so strongly?” and then answered “… strong 400 rises in incomes per head in China. it should be noted that this is not the case in agriculture. Indeed. demand for grains been so strong during the past decade that it effec.Jul 2011 who are. for the first time. 500 Energy Metals Food 2008). as noted above. Obviously.60 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 during the boom brought to focus the impact of growing Source: Worldbank demand for biofuels. April 29. including maize-based ethanol (mainly in the US) and oilseed-based biodiesel (largely Chart 4: Energy intensity of agriculture and manufacture in Europe).70 The increasing interaction between the price movements of energy and non-energy commodities 0. for as much as two-thirds of manufacture does not include the refining sector. Likewise. 2008. and Jerrett 2008). To avoid double-counting. to the extent that energy prices are likely to be the context of the super-cycle hypothesis (Cuddington elevated. and other emerging countries have raised demand for food. accounting. China resulting from their use for biodiesel? The contribution Brazil India of biofuels to the recent price boom.10 Energy Food Metals the boom years. especially by China. During the boom.. Robust demand has been the key 2009 issue of National Geographic. percent) moved in tandem. it includes both direct energy costs factor behind the food price increase between 2002 and (mostly fuel) and chemicals (the most important of which is fertilizer). It has often been argued that Strong demand has been cited as a factor behind a structural shift has taken place in the demand for the recent boom. Strong demand has played an important For example. and was there a similar impact in oilseeds. agricultural prices will follow suit. at a global level. In fact.

JOHN BAFFES currently manages the only “new” source of demand for food commodities.e. Working Paper 4682. Distortions to Agricultural Journal of Agricultural Economics 61: 398-425. (2009). Aksoy and B. Washington.org issue linked to this development—the level at which energy prices provide a floor to agricultural prices. 1986). much of Georgia. pp. indeed. between maize and crude oil prices above $50 a barrel. at all but they have also injected liquidity in the market. Issues. and contributes frequently to several internal and external World increases in food prices. Marian (2006). as analyzed extensively in the liter- The US Government Accountability Office (2009:101) ature. and Implications. MS in Agricultural Economics (University of biofuels. it is analysts often use various rules of thumb to express investment fund activity in commodity futures exchanges a perceived new relationship between the prices of that matters most. In Food Prices and Rural Poverty. Christopher L. He has written exte extensively in the areas of economic development. However.indd 17 1/26/2012 1:39:31 AM . inconclusive. trade. while the views on the effects of agri+commodities and crude oil. To conclude. “The Anatomy of Three Commodity Booms. it gave a range of that commodity prices are likely to be elevated and $80-$120 a barrel (based on anecdotal evidence from more volatile.NON-AGRI COMMODITIES DATABANK .AGRI COMMODITIES found little direct evidence that demand for grains and About the Expert oilseeds as biofuel feedstocks was a cause of the price A Senior Economist with the Development Prospects Group spike. some of these US biofuel mandates non-binding (i. (2010). M’Barek. I. DATABANK . in 2009 process. and various East African countries. ed. of speculation. www. John (2011). $75 a barrel price for others argue that not only they have not affected prices crude oil would correspond to $150 a ton for maize).” Population and Development and the World Bank. 2011.C. “Oil Spills on other Commodities. Center of Economic and Policy Research Experience. Report Policy. Baffes John and Tassos Haniotis (2010). Mr Baffes’s contributions total over 60 articles in academic journals While debates have mostly focused on the amount and books. 1983). the price this activity on commodity markets are very strong (some of maize expressed in US$/ton is roughly double that believe that they have caused a speculative bubble while of crude oil in US$/barrel (thus. In addition to the prices of these commodities (energy interviews). and sunk costs of the biofuel industry. DC: The World Bank. A. “Placing the Recent Commodity World Bank. Mitchell. the empirical evidence price of $3 a gallon of gasoline at the pump is the level has been weak. Incentives in Africa. For example.com/in/en A PwC & MCX Joint Endeavour 17 012-053_CIYB_2011_Exper's Views. 2009. numerous factors have contributed to the while acknowledging that economists have disagreed recent commodity boom. and feedstock for biofuels). A Note on Rising Food Prices. “The Energy/Non-Energy Price Link: Channels. bank’s b commodity price forecasting and market monitoring when examined from a global land perspective. “How to Understand High Food Prices.pwc. Policy Research Baffes. Washington. 1992). it involves numerous other Another frequently discussed factor has been the role elements.” Resources and Challenges of Required Increases in Production and Use. DC: World Bank. implying profitable at current energy prices). including subsidies. While in the current country c departments. While it is indeed the case that biofuels is the oof the World Bank. and been the most important factor behind the post-2005 agricultural economics. Review 34: 599-629. a permanent character. Yet. perhaps an exaggeration to argue that biofuels have including in Mexico. biofuels become factors have. John (2007). discussed often in the financial and popular press. p His other responsibilities include research on market m structure and policy reform issues in developing biofuels accounted for 1. Global Economic Prospects: Commodities at the Boom into Perspective”. and the resulting effect on prices. GAO-09-446. Since joining the World Bank in 1993. Hoekman. While the literature on speculation is still at which the maize price is determined by the oil price. Piot-Lepetit and R. trade restric. Past ed.mcxindia. Therefore. 32:126-134.” In Methods to Analyse Agricultural Commodity Radetzki. He was a key contributor to the World Bank’s flagship publication Global of food crops that have been diverted to the production Economic Prospects 2009: Commodities at the Crossroads. DC: World Bank. and Long-term Relevance. Gilbert. D. pp. Crossroads.” Anderson. Kym and William Masters (2009). Bangladesh. Donald (2009).0 per cent of global area and a OECD countries as well as policy advice to various allocated to grains and oilseeds. higher price variability by exacerbating the length and the The conclusion was based on the strong correlation amplitude of price cycles. Mr Baffes holds a BS degree in Economics (University of Athens. Nikos (2008). Springer Resources Policy 31: 56-64.” Price Volatility. Washington. Bank publications.5-2. Mr Baffes may be reached at jbaffes@worldbank. US Government Accountability Office. Other commentators (in the US) have argued that a thus facilitating price discovery). References Alexandratos. Science. 31-44. 40-70.com / www. and PhD in Agricultural and Resource Economics (University of less attention has been paid to a more important Maryland. Washington. mandates. context of high prices such share is important. “Food Price Surges: Possible Causes. Among the numerous types of speculation tions. Biofuels: Potential Effects Baffes. it is unlikely that investment fund activity The World Bank (2009) reported that crude oil prices will alter long-term price trends. it may induce above $50 a barrel effectively dictate maize prices. Although their relative weight about the circumstances that would make the 2009 continues to be an area of contention. it is Mr M Baffes has worked in several operational departments.

5 per cent from 1932-1937) economic fluctuations. GDP growth data where obtained from the Worldbank’s World Development Indicators.8 per cent from 2003-2008. The average annual price data used for these computations are from the Grilli and Yang Commodity Price index in real terms and updated as in Pfaffenzeller et al. Recent dramatic (commodity) exceeds previous price rallies during World War I (by price developments have further highlighted 34 per cent from 1913-1917). In this data set. but this may be an artefact produced by interpolation and is often modelled as a structural break (cf.indd 18 1/26/2012 1:39:36 AM . 1. Cuddington & Urzua (1989). University of Liverpool Volatile commodity markets have historically been analysed against a background of dualist interaction between a developed economic centre and an underdeveloped periphery. 2. (2007) except Timber data. T he interaction of commodity markets with Yang real commodity prices index by a cumulative total general economic activity has been a topic of of 59. commodity price cycles have impacted a more diverse set of economic regions in more diverse ways and may be showing signs of constraining industrial sector activity. which have been updated from forestry commission questionnaires from 2003. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Business cycles and their relationship with the commodity economy By Stephan Pfaffenzeller. a large decline is recorded for 1920/1921. 18 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. Lecturer of Economics. following the end of the relationship between commodity markets and the great depression (49. Grilli & Yang (1988). This magnitude lasting interest. The first decade of the 21 and around the time of the oil price shock (54 per century saw a sustained increase in the Grilli and cent from 1971-1974). More recently.

the long-term also highlights a difference between these two strands of effect was predicted to be an investment bias towards dependency theory.NON-AGRI COMMODITIES DATABANK . The question of whether such a long-term developments. a Commodity price booms could be expected from short-term interpretation of balance of payments www. therefore. relationship would hold only in the long run – with regards to secular trends in commodity prices and Commodities and developing countries earnings – or also over a shorter term is an inter- & the traditional perspective esting and potentially contentious issue in itself. commodity prices lead to higher earnings. then economic growth should be directly theoretical discussion of the commodity economy has dependent on commodity export earnings. One should also expect changes in dominate long-run developments. an obvious assertion. one should tions for commodity exporters. While increased demand from the centre can produce The commodity price boom of the early 21 century price booms. prices. If higher focussed on long-term price trends and their implica. prices reflect these changes to some degree. commodity terms of trade. climatic fluctuations in the case of agri-commodities atively large but not as pronounced as the year-on-year or from increased industrial activity in the centre (y-o-y) declines observed in 1930 (19. What is remarkable range of 6-12 per cent during the decade 2000-2009. The impact of commodity price fluctua- 24% cally will differ regionally depending on a country’s tions on commodity export dependent economic structure and level of industrialisation.4 per cent by 20092.8 per cent)1. While Singer expected a commodity the sector in long-term decline. which tend to for commodities.AGRI COMMODITIES The subsequent 11 per cent price decline is compar. these incentives take effect when earnings from This implication for business cycles in the periphery commodity exports are relatively high. here is the deterministic prediction based on demand Even after the financial crisis of 2008/2009. that high alternating with protracted price depressions has rates of economic growth are driving up commodity received some support from Cashin et al. 2007 to 7.2 per cent) since 1900. If this constraint is binding in commodity-dependent For most of the 20th century.indd 19 1/26/2012 1:40:08 AM . 1975 economies for other raw materials such as minerals (25. Commodity prices are bound to fluctuate in Cashin and colleagues document that commodity price response to changes in the supply of and demand booms are shorter lived than price falls. which could be seen as a priori Asia’s growth rates merely fell from 12. 2010 responses and regional economic peculiarities. for example.mcxindia. If While the arguments of Prebisch and Singer concen.com/in/en A PwC & MCX Joint Endeavour 19 012-053_CIYB_2011_Exper's Views. prices but also their impact on the business cycles of their interaction with economic activity generally and commodity-dependent economies. who see the main impact consider the interaction between supply and demand of commodity export earnings in At the above rate. at one level. DATABANK .3 per cent in independent. (1999). temporary rises in In particular.com / www.1 per cent) or 1938 (25. (1993). economies has been discussed A discussion of the relationship between business extensively by McCombie & Thirlwall cycles and the commodity economy should. World Singer implies a long-term supply reaction that has the GDP grew by close to 4 per cent for most years after net effect of depressing commodity prices in the long 2003 with east Asia registering growth rates in the run through a supply expansion. Inter-temporal fluctuations in commodity capital goods imports. What matters in this commodity prices to transmit throughout an integrated context is not only the cyclical pattern of commodity world market. The analysis of cyclical expect economic growth to co-vary positively with fluctuations has to be seen in the context of these commodity prices. The cyclical pattern of short-lived price booms It is. the empirical and economies. Since cycles in the affected economies. one should expect higher commodity commodity prices create an incentive for additional price volatility to translate into amplified business investment in commodity producing sectors.9 per cent). increase (24. 20th century. demand for and supply of commodities more specifi. This loosening the balance of payments saw the largest y-o-y perspective is crucial not least because it appears constraint: developing countries real commodity that the structural composition of manufacturing have been assumed to be limited in price rise since and primary sector specialisation across the world their economic growth by the amount 1900 economy has been changing over the course of the of foreign exchange available. the peripheral response discussed by was accompanied by high rates of income growth. The year 2010 and metals. The effects of commodity price changes. This analysis points to the complexity of saw the largest recorded y-o-y real commodity price cyclical variations in commodity-dependent economies.pwc. boom to bypass the nascent industrial sector. East and supply functions. Singer (1950) did comment then one should expect a direct effect on business on the impact of cyclical fluctuations in commodity cycles in commodity-dependent developing countries. In Singer’s analysis. a commodity-based balance of payments constraint trated on the predicted long-term decline in the does take effect over a medium-term time horizon. prices.

The economic relationship underlying this relative Commodities and emerging markets & price measure. has profound implications for recent developments the dynamic interaction between commodity prices Developments during the later years of the 20th and business cycles. This tendency has affected not only the primary commodities and a fall in their prices.indd 20 1/26/2012 1:40:09 AM . in turn. It has been observed repeatedly effect is sufficiently strong to substantively constrain that sources of manufacturing exports are no longer economic activity. Commodity price declines that are The traditionally assumed homogeneity of endogenously linked to preceding commodity price commodity price behaviour has likewise increasingly booms will imply that high relative commodity prices been called into question with some evidence of may not persist for a sufficient length of time to product differentiation in commodity categories which generate the required increase in commodity supply. Kaplinsky & Morris (2008) highlight to capacity building investment in primary commodity the fact that. followed by a price decline in the sustained expansion in the leading and emerging wake of the global financial crisis. inter-temporal pattern of manufactured goods prices This interaction – if consistently present – could but also that of primary commodities. This raises the question tured goods exports from the 5 leading industrialised of how likely the balance of payments constraint is to be economies to developing countries). The unilateral causation to one effective manifestation of these investment incen- of deepened functional tives will of course depend on the persistence of interdependence. ultimately to a decline in demand for economies. that of the output produced. the real price are weakened if developing economies have access to of a commodity is. it is no longer generally taken as true that fluctu. commodity booms should have ities are conventionally deflated by a developed little impact on the business cycle within commodity economy manufactured goods price measure such as dependent developing countries while in the second the MUV-G5 (an index of the unit values of manufac- case they should accentuate it. Balance of payments constraint based theories inputs into the manufacturing process. therefore. production. sufficiently high real commodity prices over time. here. the strong upwards weak primary sector on a global scale. the representative price of the input relative to position strengthens. Put differently. therefore. thus. commodities may not be sustainable within a given ations in raw material prices merely reflect how a industrial market process. in contrast to previous industrialisation sectors. Persistent commodity price century and the first decade of the 21st century booms have the dual effect of incentivising supply have seen sustained shifts in the structure of the increases and narrowing profit margins. pressure on commodity prices in recent years can Increased upwards pressure on commodity prices be appreciated in context. constrained growth would predict a temporary relaxation The notion of the commodity’s real price is crucial of the growth constraint and. dominant industrial sector interacts with a structurally Against this background. For commodity binding. it could contribute to a downturn located predominantly in the most developed centre and. needed for a sufficiently extensive supply of primary Thus. One possible expectation against this background would. a relative price: in this alternative foreign exchange sources and if their reserve case. and the commodity There are countervailing factors to this recent tendency though. a domestic boom. If the latter commodity economy. High-income simply have the long-run effect of limiting industrial growth rates in China and India in particular have put activity with a given level of technology in commodity upwards pressure on primary commodity prices. Rising commodity prices have the economy appears to shift potential to support exploration of less accessible from a pattern of primarily non-renewable commodity deposits or to motivate investment into higher production capacity. These investments gave rise to predictions episodes in East Asia. Prices of internationally traded primary commod- In the former case. and these in turn will depend on sufficiently high sustained demand for commodity inputs in production. have conventionally been seen as homogeneous (cf. thus. the emergence of the rapidly of a much more muted price recovery following a growing Chinese export sector differs substantially renewed acceleration in economic activity later (Inter- in impact due to the sheer size of the emerging national Monetary Fund 2009). the elevated relative price level Kaplinsky 2006 for a detailed empirical discussion). be a sustained reversal between business cycles of the historic commodity decline. The sharp increase 20 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY The relationship economy. The commodity price can be expected to persist against a background of boom in 2008. had already led Asian economies.

pp.pfaffenzeller@liverpool. has recently imposed by limited primary commodity reserves ppublished in journals such as ‘Armed Forces and SSociety’. In the case of commod. thus. 99(396)..com/in/en A PwC & MCX Joint Endeavour 21 012-053_CIYB_2011_Exper's Views. pp. Cyclical instability changes benefiting commodity-exporting economies. 2006. The Bottom Billion: Why the Poorest Countries are Export-oriented Industrialization in SSA. Terms of trade Commodity prices had a volatile trajectory with a improvements will normally take the form of a real weakly declining trend throughout the 20th century appreciation and. A. U. therefore. Dr Pfaffenzeller may be reached at Commodity cycles and developing ss. P.ac. 1989. one should expect will likely translate into an improvement in the terms of it to also perpetuate pattern of domestic economic trade and. Considering the documented in the so-called ‘Dutch disease’ case..L. Long Run Shows. and the Terms of Trade of Developing Countries: What the Economic Review.com / www. 1988. instability in response to fluctuations in export However. Revisiting the revisited terms of trade: Will China Primary Commodity Prices. & Thirlwall. but experienced a sustained recovery during the tiveness. 1999. Kaplinsky. The World Bank Economic Review. At LLecturer in Economics at the University of Liverpool. 2008. H. World Economic Outlook.uk countries From the perspective of emerging markets and developed centre economies. 2(1). Booms and Slumps in Kaplinsky. pp. it highlights the continued constraint PPfaffenzeller. 1993. Do the Asian Drivers Undermine Collier. & Rayner. The Economic Journal. J. (2008) for a summary discussion). American Economic Review. one should indication that a shift is also underway. C. International Monetary Fund.NON-AGRI COMMODITIES DATABANK . References Cashin. J. DATABANK . Trends and cycles in the net barter McCombie. & Yang. International Monetary Fund.indd 21 1/26/2012 1:40:09 AM .473-485. who is a macroeconomist. Manufactured Updating the Grilli and Yang Commodity Price Index. of trade may itself be problematic. OUP Oxford. A. Foreign Investment in Underdeveloped Areas International Monetary Fund. Collier booms – can constrain economic activity in the centre. The World Bank Goods Prices.981-995. from a non-fuel also consider a similar impact on potentially viable commodity economy. Palgrave Macmillan. World Development..S. He upwards pressure on commodity prices. tend to erode export competi.. There is some ity-dependent underdeveloped countries. Balance of Payments Constraint. McDermott. S. & Scott. They can.. which is unilaterally dominated nascent export sectors. To constraints to be relaxed through commodity directed the extent then that commodity dependence tends FDI and export earnings. P. Working Paper of the International Monetary make a difference? World Development. Singer. International Monetary Fund. J. World Economic Outlook: Crisis and Recovery. A. 34(6).S. Economic Growth and the terms of trade: a new approach. Newbold. 2009... appears to shift from economic growth describes long-term phenomena a pattern of primarily unilateral causation to one of with relevance beyond the business cycle.mcxindia. Cuddington. seen as somewhat DR STEPHAN PFAFFENZELLER is a D surprising (International Monetary Fund 2011). 2007.1-47. Primary Commodity Prices. R. be expected to have lasting implications for could in principle be seen as quasi-redistributive the nature of cyclical fluctuations. Tensions from the Two-speed Recovery: Unemployment. 2011. 36(2). E. www. pp. therefore.. Pfaffenzeller. one should expect foreign exchange to co-vary inversely with sectoral diversification. 2008.pwc. This phenomenon is most prominently first decade of the 21st century. and Capital Flows. Fund. the improvement in the barter terms earnings.. ‘World on world economic activity and the persistence of EEconomy’ and ‘Journal of Time Series Analysis’. A Short Note on Grilli.P. Commodities. 40(2). a shift from the traditional erodes the export competitiveness of previously dualist structure between developed and underde- viable competitive sectors. Failing and What Can Be Done About It. On the other hand. make capital imports more affordable. thus. R. in the domestic economy can generally be expected On the one hand. deepened functional interdependence. rising commodity prices however. ‘Journal of International Development’. rising to endogenously impede the emergence of more commodity prices in commodity-dependent economies advanced complementary sectors. & Morris.C. The relationship between business cycles and the The interplay between Dutch disease effects and commodity economy. pp. P. The suppression of export by centre economy demand pattern to one in which potential can thus pre-empt growth take-off in small commodity shortages –and associated commodity open but non-industrialised economies (cf. Dr the same time. 1950.AGRI COMMODITIES in commodity prices seen in 2010 in a situation of About the Expert continued crisis is. M. structural changes in the international distribution where a booming.. & Urzua. veloped economies has been observed. economically dominant sector of production and trade.. aalso contributed significantly to a number of books oon economics. 21(1).254-273.1-13.426-442. pp. (WP/99/115). April 2011: -the Distribution of Gains between Investing and Borrowing Countries. M.

separation of financial and non-financial aspects of a commodities transaction. and exploring ways to satiate investors© portfolio diversification demand if commodities ± among other asset classes ± become off-limits for them. eschewing selective targeting of products and structures which could channel liquidity into riskier alternatives. Bourse Africa Amidst a raging debate on the causal influences of recent commodity price dynamics. Director of Strategy. See Ann Berg. the best ways of addressing financialisation ± if found producing prejudicial impact ± could involve: differentiation between `financial' and `non-financial' participants. at the intersection of supply and demand (or ‘the Recently. in Safeguarding Food Security in Volatile Global Markets. markets. T he impact of non-commercial players — to the detriment of the commercial commodity chain particularly. price scale non-commercial participation in commodity discovery — and whether the participation of non-com. UNCTAD Secondly. as per classical economic theory. which has speculative market participation exacerbate volatility assumed particular prominence in the context of the 1. The Rise of Commodity Speculation: From Villainous to Venerable. FAO 2011 22 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views.indd 22 1/26/2012 1:40:12 AM . efficiency. ‘financialisation of commodities’ (for example. The counter-argument has below) — in commodity markets has long usually been to highlight the liquidity. price volatility—whether the dynamics of 2009) — a modern variant of this theme. there has been raging debate on the fundamentals’). firstly. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Can the commodity economy be decoupled from the financial sector? By Adam Gross. infor- been a source of analysis and debate1. The mational and arbitrage benefits arising from large- central aspects of contention have been. the classic exposition of which is identified mercial players moves prices away from an equilibrium with Holbrook Working. speculators or investors (defined and those dependent on it.

June 2008 and June 2011 individuals or firms with direct exposure to the physical commodity by virtue of their ordinary business opera- tions — as producer. but participate for the purpose in particular. the period when before appraising the desirability and feasibility of ‘financialisation’ is said to have taken place. the three crucial elements are the volatility? If so. Are the recent changes in the contain a proportion of commodity futures relative nature of non-commercial participation in commodity to portfolios that contain only traditional asset markets adversely affecting price discovery and classes’. The Financialization of Commodity Markets.indd 23 1/26/2012 1:40:15 AM . such direct exposure. Banque de France.AGRI COMMODITIES commodity price spike of 2006-7 and the subsequent on their assessment of the risk-return properties that global financial crisis. in the forum of the Group of Twenty (G20) nations — as well as in the practical business of regulating and Recent developments operating commodity markets around the world. processor. following UNCTAD 20092. if it exists. user or The data shows how the period 2005-2007 saw consumer of commodities. easing took OTC activity by end-2010 to half the The ‘financialisation’ of commodity markets can be level it had reached by end-2005 (US $2. low or negative correlations with other asset classes. the volume spike the market with the aim of benefiting from an antici. 9 (December 2006. Non-commercial partici. ‘based originate from a transfer of activity from the OTC 2. cannot apparently be replicated by simple linear combinations of assets. The commodity economy will be taken to refer both to the market for transacting the physical commodity and the market for financial derivative instruments in which commodities are the underlying asset. Commod- ities will be taken to include the sectors of agriculture. where specu.com/in/en A PwC & MCX Joint Endeavour 23 012-053_CIYB_2011_Exper's Views. OTC and exchange-traded derivatives volume all Definitions assets and commodities (non-gold) 2005-2010 First. became a crash between mid-2007 and early-2008 pated price trend. thus. reversing the trend. United Nations Conference on Trade and Development (UNCTAD) Trade and Development Report Chapter II 3. whether through exchange-traded central-counterparty-cleared mechanisms or in over-the-counter (OTC) transactions Note: OTC volume data is measured in terms of notional amounts outstanding in USD billions as in December of the quoted year. trader. DATABANK . in the growing role outstanding by 2010-end compared with $5. investment or arbitrage. witnessed a remarkable increase. In fact. treat commodities as ‘an asset class’3.pwc.NON-AGRI COMMODITIES DATABANK . it is notable that OTC commodity volumes in two related markets to benefit from an identified exhibited a much more torrid crisis. increases in volumes across OTC and exchange- pants are considered to be those that do not have traded markets. investment is defined as creating a — the onset of the global financial crisis — albeit with portfolio of positions across asset classes with the exchange-traded commodities retaining not less than aim of achieving a targeted risk-return profile.com / www. though from a lower lation is defined as taking an uncovered position in base. exchange-traded commodities of speculation. albeit considered here on a disaggregated basis due to space constraints. standing in millions as in December of the quoted year. arbitrage is defined as taking simultaneous positions However. in its Financial Stability Review no. it is important to set out definitions of important terms. pp 31-38). energy and metals/minerals. at the global level participation of financial investors on this basis.mcxindia. both sets of data have been rebased to 100 for the year 2005 Commercial participants are considered to be Source: Bank for International Settlements Quarterly Review. and for commodities. In short. and the increasing policy discourse — for example. their changes? Such questions feature prominently in the role in portfolio diversification. and double the volume compared with 2005.525 billion defined. www. starting with the general terms before moving to the key term under review – ‘financialisation’. As with all asset classes. exchange-traded volume data is measured in terms of contracts out- where two counterparties trade directly. poses the question: Does the by portfolio diversification considerations that are increase in volumes of exchange-traded commodities unrelated to commodity market fundamentals’. it is notable that the subsequent accrue theoretically risk-free profit. ‘motivated The data. This Data from the Bank for International Settlements essay analyses the key dimensions of financialisation Quarterly Review (see chart) throws some light on and evaluates its impact on commodity markets developments during 2005-2010. in general. what should be done about these emergence of commodities as an asset class. While they also pricing inefficiency between the two markets and surged during 2007. defines an asset class as bearing three criteria: outper- forming risk-free returns.100 in commodity markets of financial participants who billion for 2005).

PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Thus. which quantified index investment by institutional cally heightened sensitivity to the risk of counterparty investors in excess of US $200 billion by 2008. composite indices with the easing of OTC activity and the surging of exchange. per discussion below). metals different factors and involving different sets of market and energy commodity futures from across various participants — and.pimco. Perhaps. in which the floating leg of the 4 A particularly noteworthy contribution was Gorton and Rouwenhorst (2004) – ‘Facts and fantasies about commodity futures’ (NBER Working Paper 10595) 5 Ibbotson Associates (2006) ‘Strategic Asset Allocation and Commodities’. However. mid-1980s. larly following Lehman’s insolvency. we see that the crisis. commodities were being touted as also important to note that those organisations that an emerging asset class4 with characteristics that maintained the indices received ‘hedger exemptions’ made it a lucrative bet for all market conditions. up default. On the other. particu. the Commodity Futures Trading Commission (CFTC). many of these structures involved positions on both OTC and exchange-traded markets. differential composition blending a weighted basket traded activity unrelated phenomena. driving trade volumes into exchange-traded from $15 billion in 20036. and the structure of these products may help explain the above data in this light. It is pre-Crisis years. On the other hand. base metals and energy enabling theoretically limitless accumulation of the instruments were a proxy bet on the hyper-growth passive long positions that such indices replicate.indd 24 1/26/2012 1:40:17 AM . such as hedge funds). a diversified commodity index The earliest of such indices were founded in the was described as a means to attain ‘portfolio insur. in particular. Product structure It is undeniable that certain products and struc- tures for investments in commodity markets shot to prominence during the last five years. led to a dramati. available: http://www. an OTC counterparty clearinghouse. emerging economies. driven by of long positions in near-month agriculture. it commodity futures. marketplaces where counterparty risk was virtually A second area of focus in some literature7 has eliminated through the mechanisms of a central been the rise of commodity return swaps. from speculative position limits in key jurisdictions. while opment occurred in the mid-2000s. in a 2008 staff paper of the US derivatives regulator. as demonstrated gold retained its long-standing ‘safe haven’ status. Notably. the most striking trend was the rise of commodity indices. In the position must be rolled into the following month. generate higher exchange volumes. These indices replicate a passive long strategy in pretative weight to the analysis. there is qualitative support that the trend represents new types of investment into commodities – a true financialisation.com/LeftNav/Viewpoints/2006/ Ibbotson+Commodity+Study. a key feature in terms is clear that the popular view among the investment of market impact is the roll yield as the current near- community has increasingly viewed the commodities month expires or enters delivery period and the index’s space as ripe for increased asset allocation. We may look to qualitative factors to add inter. On the one hand. there is also support that the trend represents a transfer of activity from OTC markets to exchange-traded markets – a shift in product structure – as participants sought to protect themselves from counterparty default risk prevalent in OTC markets by finding new structures and instruments that. This was dramatically instrument in which banks and other sophisticated illustrated by the smooth winding up of Lehman’s financial institutions swapped cashflows with clients exchange positions compared with the many years and (commercial hedgers or speculative participants billions of USD spent unwinding its OTC obligations. the most well-known of which are market into exchange-traded marketplace? Or. but the most significant volume devel- ance’5 and providing a hedge against inflation. the completely new exchange venues (or do so synthetically through a financial investors purported? commodity swap arrangement. were the SP-GSCI and DJ-UBS indices. Investments into agriculture.htm 6 CFTC Staff Report on Commodity Swap Dealers and Index Traders with Commission Recommendations 7 See Berg 2011. per footnote 1 24 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. by their consequence.

as financialisation increases. send orders and execute trades based on algorithmic programs.8 investors. OECD Working Paper 27 10 See footnote 2 above.com/in/en A PwC & MCX Joint Endeavour 25 012-053_CIYB_2011_Exper's Views. While the CFTC 8 E. then to that extent.mcxindia.com/article/2011/06/17/us-commodities-highfrequency-fb-idUSTRE75G0MY20110617 ) 9 The Impact of Index and Swap Funds on Commodity Futures Markets: Preliminary Results. DATABANK .AGRI COMMODITIES swap is defined by the price. The hypothesis that is often tested is the level of correlation between commod- ities and non-commodities. in the natural gas market (see Reuters 2011 http://www. A strong counterblast may be found in two High-frequency traders use electronic systems that UNCTAD reports of 200910. slightly lower than for and volatility exacerbation effects without adversely equities and financial futures.525 billion by end-2010. the author points mentioned above. followed by prices bouncing back within minutes. selective targeting of particular products or struc- Specifically within the latter. affecting market liquidity. likewise the volume or proportion unfavourable impacts. In a nutshell.pwc. into the market’s price formation process. anecdotal evidence shared However. if products and instruments such as nities or investment strategies dependent on being commodity index and swaps investment distort price ahead of the market with an informational advantage. an 8% fall in 15 seconds.com / www. the subject of correlation is an important issue. Space constraints preclude a thorough exami- nation or assessment of the many analyses and research papers that have investigated the purported causal impact of ‘financialisation’. especially for energy nowadays compiles more extensive statistics and and metals products.405 billion for 2008. a subject of debate not just with respect as to whether and the extent to which index and other to commodities but for every asset class in the wake financial investors have impacted commodity prices. typically exploiting arbitrage opportunities Decoupling: desirability and feasibility for very high volumes of small profit-making opportu. as For the purposes of this paper. sation (in commodity markets) on the markets tend to The first challenge arises if regulators pursue assess two metrics: price volatility and price discovery. as well as The Growing Interdependence Between Financial and Commodity Markets. of overall trade. However.100 the subject of intensely contested debate.reuters.NON-AGRI COMMODITIES DATABANK . as opposed to what notional outstanding of commodity swaps and other causes a non-directional increase in liquidity. thus generating volume in both the and Supplemental reports. billion by end-2005 to $8. the challenge is to 30-40 percent of total volume on some of the leading calibrate a response that eliminates the price distortion global commodity exchanges. While actually causes price movements. the analytics as to what OTC and the exchange-traded marketplace. even if it were to be shown that such with the author suggests that HFT may range between unfavourable impacts existed. who identify a range of studies that find statistically A third area of focus has been High Frequency significant conclusions on both sides of the debate Traders (HFTs). Such studies differ according to the nuances of statistical method.indd 25 1/26/2012 1:40:19 AM . volumes post-crisis subsequently on index investment to Irwin and Sanders (2010)9. UNCTAD Discussion Paper no. slumped to $2. discovery away from the fundamentals and exacerbate The literature on HFTs as applied to commodity volatility.g. remains commodity OTC products increased from $5. in particular. the key challenge of differentiating defin- itive causation from mere correlation. or between different commodity sectors. 195 www. This is identified as arising from the fungible nature of investor inflows that can be deployed and redeployed across asset classes per the perceived evolving risk- return characteristics of each. The swap writer usually lays off more disaggregated classifications on the positions the exposure arising from the swap in the commodity of large traders in its Commitment of Traders (COT) futures market. of the so-called ‘flash crash’ of May 2010 – although Irwin and Sanders themselves tend to be sceptical certain extreme and abnormal market movements about distortionary effects arising from index have also been observed in the commodities sphere. their presence may legiti- markets specifically is more limited than for the other mately be discouraged or controlled to eliminate the two instruments. and without deterring the participation of arbitrageurs and those speculators Market impact whose participation brings valuable new information Studies of the impact of various kinds of financiali.

PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY About the Expert given that systems for dematerialising warehouse receipts to readily tradable electronic instruments are ADAM GROSS is the founding Director of Strategy A increasingly widespread – could be at least equally at a Bourse Africa Limited. on $200bn Was the institutional dynamics .com remains of vital importance to the many public institu- tions such as governments and public pension funds. he worked in various emerging markets to analyse the impacts of commodity exchanges quest for diversification becomes simultaneously on economic and social development in the context of these markets.gross@bourseafrica. increasingly popular strategy and many large investment international in development and commodity exchanges. up exploration and development activities in the Should policymakers seek to squeeze financial minerals and energy sectors. While increasing example. In particular. thus reversing the trend – documented in witnessed over the last 5 years are more reflective of the BIS data above – that has seen volume growth structural changes in the global economy. many commodity trading firms render commodities a less attractive destination and ‘traditional commodity speculators’ follow exactly for 'financial' investors . Gross contributed to the devel- opment o of global best practices in operations. marketing. for in the developing world. management. such an approach risks liser . especially relatively straightforward to classify.) benchmark index structures into micro-indices.then it is important to ameliorate prejudicial the other. leading to hoarding and physical market Financial F Technologies Group and African institutional distortion. Mr. and as volatility has risen. This may remove the viability of was of course a key contributing factor to the origins the commodity index altogether. Diversification reached at adam. for example. as a purely financial classes would over a medium to long term horizon transaction. However. such as OTC commodity return highly contested. commodity transaction. the key is to remove bottlenecks to stated policy goals of key markets such as the EU. 'financialisation' a second definitional challenge would has been the key trend driving price arise: whether a clean-cut distinction can be made on the one hand between ‘financial investors’ and other market participants and.a seemingly natural stabi- the same strategy. Gross may be more challenging yet more important. the increased production of agricultural products.indd 26 1/26/2012 1:40:20 AM . who have critical need tures. However. and the wider investing public. the impact push volume out of commodity indices into different of 'financialisation' on commodity prices remains structures altogether. which in leading venues. as well as in other clean technologies that reduce the commodity inten- commodity futures investment strategies siveness of economic growth. It may seem the livelihoods of millions. the with the United Nations Conference on Trade and Development (UNCTAD). This would mean that strategies that may be pursued in other assets? (And such managers become bound by speculative position literature has highlighted. coupled with supply commodity futures markets and volume shrinkage in constraints that have hindered an effective response. m and strategic positioning of some of the world’s The third challenge lays in the nature of investment leading multinational companies compan across industry sectors. Mr. A trend that is in line with widely In this analysis. the OTC market. the dangers limits that apply to many commodity futures contracts of bubbles in other assets such as real estate. he assisted with within the Post-Crisis environment. Mr. It may On the other side of the debate. Some suggest the price dynamics swaps. to remove the ‘hedger exemptions’ become off-limits. especially in the more transparent and more closely regulated the rise of the 'BRIC' economies. commodity inventories in proprietary facilities.with effects including the distortion of price discovery and the exacerbation of volatility . step US. if. If commodities the CFTC itself. as critics contend. including by and falling as much as 10% in a day. There is no doubt this is becoming an investors. in has a background comprising corporate strategy.that may not be of much comfort to those encouraging a financial investor to buy and hold the seeing their staple foodstuffs becoming increasingly physical commodity – an increasingly viable option unaffordable. are there viable diversification provided to the index managers. between the financial investors' index investment effects on sectors of critical impor- and the commodity aspects of a by 2008. At UNCTAD. up from tance for the global economy and on $15bn in 2003. while investing in new participation in OTC swaps. For example. As a member of the within and across asset classes have increased United Nations Secretariat. 26 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. or fragment large of the global financial crisis in the first place. aside from commodity index investment. As correlations the strategic development of the Multi Commodity Exchange of India. Gross featured as a specialist on commodity exchanges and remained high. a new pan-African commodity exchange e and multi-asset trading platform promoted by problematic. Moreover. a fund that buys paper without correlation of commodities with other asset taking delivery of the asset. Japan and others. attention may focus primarily on to avoid over-exposure to volatile assets such as squeezing the volume generated by commodity indices stock markets which – in mid-2011 – have been rising – and indeed proposals have been made. As a banks appear to be moving towards holding large-scale corporate c strategist.

NON-AGRI COMMODITIES DATABANK .indd 27 1/26/2012 1:40:23 AM .com/in/en A PwC & MCX Joint Endeavour 27 012-053_CIYB_2011_Exper's Views. DATABANK .AGRI COMMODITIES www.mcxindia.com / www.pwc.

and discusses the various global regulatory responses. commodities are heterogeneous in nature. speculative investments by financial investors. Growing physical demand for commodities. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Recent trends in global commodity prices and regulatory responses: Which way now? By Partha Ray. Indian Institute of Management . and globally accommodative monetary conditions – all have been talked about. F rom the year 2000 until the advent of the global financial crisis. commodities markets had been on a levitating journey.Calcutta Of late. speculation and global liquidity. This was followed by a number of regulatory responses across the advanced countries – from Dodd-Frank in the United States to legislations for central clearing in the European Union (EU). While at a broad level of 28 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. supply shocks such as adverse weather and geopolitical risks. followed by a nose-diving in 2008. this paper traces the role of various forces such as growing demand. In probing the possible reasons behind the phenomenon. The nose-diving of commodity prices in 2008 brought the key issue of presence of fundamentals versus specu- lation to the fore once more. a legitimate question: which way are commodity prices headed? What are the constituents of the catchall term called ‘commodities’? Admittedly. At the current juncture when commodity prices are again on the rise. experiencing steep increases until the advent of the global financial crisis and. subsequently. commodity prices have been on a roller-coaster ride. Professor of Economics. Various reasons have been put forth for this consistent upward movement of commodity prices that lasted close to a decade.indd 28 1/26/2012 1:40:23 AM .

section 5 is in the nature of crystal ball grazing. global growth. Instead Source: Worldbank of presenting any concluding observations. It is also well documented that these spurt in commodity prices in 2008 in terms of the rapid countries are accounting for larger shares of annual growth of emerging economies such as China.com/in/en A PwC & MCX Joint Endeavour 29 012-053_CIYB_2011_Exper's Views. World Economic Outlook Database.9 115. while the global growth has staged a comeback. First. Long-term trends after experiencing a dip in 2009. have been contributing to oil price increases (Calvo. For expository convenience.mcxindia. 2008). primarily China – is playing Xiong. better than a random walk forecast of commodity prices (IMF. Sections 2 and 3 are devoted to long-term and recent trends in commodity prices.1 4.6) (-30. there is another prices later fell sharply as the demand faded with the viewpoint that excess liquidity and low interest rates advent of the global recession (Krugman.2) that as prices started fluctuating substantially around 2005. the forecasts became more inaccurate and Note: Figures in brackets are year-on-year percentage changes.0 direction and persistence. Regulatory initiatives are taken up in section 4. energy prices index fell to 214 in 2009 from 342 in 2008. the including food and metals.0) (26. 2010). Nevertheless. There are two opposing views (Tang and countries – BRIC countries. oil consumption growth. EMEs. registered a fast As a perspective. very sharp rise during 2010. Often their demand-supply configurations and pricing trends are different. it may be useful to start with the recovery in 2010 – thanks to the well-coordinated long-term trends in commodity prices. commodity price inflation could be close to the beginning of the great recession in 2008 when 30 percent in 2011 (Table 1). and if the current trends Commodity prices shot up from the early 2000’s to continue. What have been the recent trends in commodity prices? As per recent data from the IMF.pwc. and speculates Recent trends the shape of things to come in commodity markets. commodity prices Table 1: Global Growth and Inflation have started rising since then (Chart 1). Increasingly it is asked whether speculation 2000’s. Interestingly. A key feature of international food and energy 2008 2009 2010 2011 price movements is that it is difficult to predict their GDP Growth 2. despite the spectre of inflation has been visible in some of the fluctuations over the thirty-year period of 1970-2000. India and Brazil. this period of lull. In fact. Source: International Monetary Fund.8 (27.AGRI COMMODITIES aggregation. coal and various metals.indd 29 1/26/2012 1:40:25 AM .com / www. commodity prices started rising during growth has been primarily supported by the emerging the 1970s.8 148. the International Consumer Price Inflation 6. While commodity prices in general and food and fuel www.5 3. This got reflected not only in oil and markets like China. industrial inputs. Third. natural gas. 2008). energy prices. Interest. metal sees speculation as a key responsible factor behind and food the upward movement in commodity prices. commodity prices have experienced a volatility in commodity prices was range-bound. After an initial rescue packages adopted globally. What have been the long-term trends in commodity prices? What has been the recent trajectory of commodity prices? Have the recent regulatory actions been steps in the right direction? This essay seeks to address some of these questions. 2008).7 5. the present essay is organized as follows.0 Monetary Fund’s forecast performance has indicated Commodity Price (2005=100) 181. 2011). 2000=100) as food and beverages. Second. In fact. commodities can be segregated into Chart 1: Long Term Trends in Global Commodity Prices energy and non-energy. The recent increases in commodity prices have Three major explanations are offered to explain generated heated debate in academia and policy circles this phenomenal increase in commodity prices since alike. After all.NON-AGRI COMMODITIES DATABANK . futures markets forecasts do not perform much April 2011.1) (29. they include items as diverse (US dollars.8 -0. there is yet another explanation that Commodity prices & energy.7 5. DATABANK . but also in the prices of non-energy.0 2.1 200. there is an influential thinking that caused unwarranted increases in the cost of energy increased demand from fast-growing developing and food. crude oil (petroleum). With the recovery in sight. ingly. missed the turning points in 2008 and 2009. Admittedly. An influential view sees the whole issue an important role in high commodity prices (Helbling in terms of supply and demand and rationalizes the et al.

Source: International Monetary Fund. a tight market situation for wheat concerned. 30 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. Sugar. 2011). As far as world’s known oil reserves are 2011). Interestingly. Source: International Monetary Fund.7 184.1 97. the dramatic fall in OECD oil agriculture and food prices are 77 and 60 percent demand during 2008Q1 . China seemed to have surpassed OECD 2). West Texas Interme ate. agricultural raw material price include 4. OPEC countries account for 72 percent of was aggravated by drought in Australia. Apart from the technological advancements.5 146.5 116. Metals prices are up almost 170 percent while countries. The issue of food and agricultural prices is much major factors determining the future of energy prices more complex. Includes Crude oil (petroleum). going forward contributed to the 2007 .0 Memo: Petroleum Price 64. With OPEC’s spare capacity at about 6 2000. their low of 2009 (Chart 4). another total world liquid fuels is slightly below 40 percent important supplier. (Table 2).3 71.than doubled.indd 30 1/26/2012 1:40:26 AM . end-2008. Cotton. also experienced weather related and its share of crude oil production is little above low yields for several crops. April 2011 April 2011. Since both OPEC and non-OPEC regions. 2. energy prices have more. Food and fuel prices peaked in 2008 at levels million barrels /day and substantial known reserves. Note: Food prices includes Cereal.1 Natural Gas Price Index3 115. Canada. Major Components Chart 3: World Oil Demand Source: Worldbank Source: International Energy Agency. oil production continues to grow in lows during the depth of the financial crisis. As far as world oil demand is concerned.7 Petroleum Price index2 120.0 61. Timber. and American Natural Gas Price Indices. Seafood. World Economic Outlook Database.9 148. and Coal Price Indices. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY prices in particular have risen dramatically since 30 percent. World Bank Fuel prices Crude oil prices have recovered from the crash of late Food prices 2008. Meat.2008 food price increases.3 Coal Price Index4 104. recovered quite higher.8 148.8 79.9 173. However. Includes Australian and South African Coal. In fact.8 206.2008 and again in 2010 (G-20. the energy sector is bound to face environmental Climatic factors have also contributed to the price challenges that could affect its long-term outlook rises in 2007. 2011). 3. an important the global total.6 113. Vegetable Oils. since but still remain well below their former peaks (Chart early 2003. More recently. Food prices have recovered from include the role of financial investors in fuel markets. Natural Gas. Wool. Hence. and Oranges Price Indices.2009Q2. OPEC’s production share of supplier of wheat to world markets. and Hides Price Indices. fast and surpassed China in the fourth quarter 2010 (Chart 3).9 115. Japanese.3 116. In 2008.3 181.5 133.2 131. 80 percent and 250 percent above the levels in 2000 the oil market does not appear be affected by resource (IMF. World Economic Outlook Database.0 (US$ /barrel) 2 Notes: 1.4 137. Simple average of three spot prices: Dated Brent. and the Dubai Fateh. Rubber. respectively (World Bank. Bananas. Includes European. Low stocks and uncer- inventory levels and political turmoil in the Middle tainty about stock levels in some parts of the world East and North Africa region.6 265. Besides. drought Table 2: Trends in Energy Price Indices Chart 4: Agricultural and Food Prices (2005=100) 2006 2007 2008 2009 2010 Energy Price Index1 119. the China factors alone cannot be Chart 2: Recent Trends in Commodity Prices (2000=100): held responsible for increased oil demand. Commodity prices have surged since their scarcity.7 109.

9 135.7 global economic crisis in 2008.5 196. 2011.3 229.mcxindia. thus.7 355.6 235.0 189. Besides. DATABANK . LME spot price. inflation (Gokarn.6 Although the crash in commodity prices in late 2008 affected minerals prices. been challenged in recent times. CIF European Ports 8) u3o8 restricted price. often in response to policies imposed by international financial institu- tions that dismantled State support to the agricultural sector. Further damage was wrought by the heavily distorted nature of the international trading system that required many developing countries to open their markets.6 87. of emerging market economies like China and India however.0 284. Illustratively. they seem to have Zinc6 236. effects of climate change” (UNCTAD.4 recovered and most mineral prices are again above Lead7 132.0 130. Illustra- cannot be ruled out.AGRI COMMODITIES followed by fire in the Russian Federation. the trade volume of financial instru- of the world.1 156. the theory say in this regard? The traditional specu.4 136. Such views have. which 7) LME spot price.3 147.0 184.6 160. In addition. it has been tively. The outcome of this neglect and underin- vestment has been a lagging supply response and an increased vulnerability of production. LME spot price 5) Melting grade.9 consumer (Chart 5). CIF UK ports 3) China import Iron Ore Fines 62% FE spot (CFR Tianjin port) An important issue that has come to the fore in the 4) Standard grade.NON-AGRI COMMODITIES DATABANK . over underinvestment for several decades in many areas the last decade. for India.1 164. This is due in part to the low commodity ments linked to oil (and commodities.2 264. The nature of commodity markets has undergone Apart from these short-term factors. who trade based on irrelevant information) in population and rising living standards in a number will not survive in the marketplace. Nickel5 163. since the days of the Aluminum2 135. p.8 176.com/in/en A PwC & MCX Joint Endeavour 31 012-053_CIYB_2011_Exper's Views. China has surpassed Iron Ore3 119.6 521.3 130. A recent UNCTAD report candidly increased number of financial participants in the oil observed: futures market over 2000-2008 bears testimony to the “Agricultural production has suffered from chronic ever-rising phenomenon of speculation.4 Speculation versus demand pressure: Notes: 1)Grade A cathode.pwc.3 251. In fact.2 the OECD countries in terms of world’s leading metal Tin4 118. and several that profitable speculation must involve buying when downward revisions of US crop forecasts in late 2010 the price is low and selling when the price is high.5 220.6 210.2 275. long-term a transformation since 2000. fears about lative stabilizing theory of Friedman (1953) suggests the Australian and Argentinean crops. in general) has prices of the 1980s and 1990s that discouraged increased sharply on both commodity exchanges and investment. 1990).1 194.4 140.com / www.3 for the past decade. Uranium9 170.0 250. World Economic Outlook Database.5% minimum purity.5 257.3 143. notably to the Source: World Metal Statistics. It.4 138.5 164. agricultural production in many developing countries was disrupted by government Chart 5: World Metals Consumption neglect and underinvestment.8 114.3 219. CIF European ports Who is the real villain? 2) 99.1 long-term averages (Table 3). 9) Table 3: Trends in Metal Price Indices Metal prices (2005=100) Growing demand for minerals from China and other 2006 2007 2008 2009 2010 2011 Asian economies has marked the minerals markets Copper 1 183. and neglect of agriculture in a number of countries there have been enormous inflows of capital into have been held responsible behind high food and these markets. it has been shown that noise traders might have shown that increasing demand for proteins arising as an impact on prices if they hold large share of assets an inevitable consequence of rising affluence is a regardless of their survival in the long run (Shleifer major responsible factor behind recent surge in Indian and Summers. 2010).5 120. LME spot price.3 250. Nuexco exchange spot has always been a source of controversy. April 2011 www. CIF European ports context of recent commodity price hikes is the role of 6) High grade 98% pure speculation/speculators in commodity markets.5 205. Indeed.9 629.7 214. What does Source: International Monetary Fund.8 368.indd 31 1/26/2012 1:40:27 AM . and early 2011 have brought soaring prices. while continuing to allow developed countries to depress their agricultural prices through massive subsidies. With the deregulation factors such as under-investment in agricultural sector of over-the-counter (OTC) derivatives in early 2000s.1 99. The rise in crude oil prices and the agricultural prices.8 167. LME spot price. predicts that irrational speculators (or noise the role of increased demand arising from increase traders.

for example. the open futures positions held by financial traders (hedge funds and non-registered participants) grew sharply — from about 45. and the global short-term interest rate. There have effect of investors' risk appetite however been some evidences of this phenomenon in 3) Supply shock in physical commodity markets +106. there have been some technical works Commodity Derivatives to quantify the impact of each of the major factors behind commodity prices. the earlier commodity boom (January 2007 to June 2008) occurred as substantial capital flows (from asset markets such as securiti- zation and stock markets) entered commodity markets (Table 4) – a phenomenon that has been termed as “flight to simplicity” (Kawamoto and others.4 -66. the global equity index (MSCI Source: Kawamoto and others.2 the commodity economy (UNCTAD. In fact.. 1 For instance.indd 32 1/26/2012 1:40:28 AM . 1990 to March 1. 3 The investors who allocate a portion of their portfolios to “investments” in the commodities futures market have been termed “Index Specu- lators”. 1990.4 cross-market linkage.5 +30.2 Furthermore. of which two deserve special mention.1 In fact. to more than half a million futures in 2008. and investment flows into financialised commodity markets First. 12 AC World Index) and the commodity index (S&P GSCI). 4 These are correlation over a cumulatively increasing time span. p. 32 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. from less than 20 MSCI AC World Index S&P GSCI percent of all open futures and futures-equivalent option positions in 2000 to over 40 percent in 2008. worth over $200 billion in 2008. between the commodity market and the stock market. the point corresponding to 01-03-1990 in the horizontal axis refers to correlation coefficient calculated over January 1. regulatory changes. with fixed starting point as January 1.8 +14.1 consensus on this issue of impact of financialisation on 2) Future demand for commodities and the +3. Chart 6). It has been pointed out that these investors behave very differently from the traditional speculators that have always existed in this marketplace (Masters.0 100. 2011.3 Source: Author's calculation from Bloomberg data. the total value of various commodity- related derivative instruments purchased by institu- tional investors has increased to more than $2 trillion in mid-2008 from an estimated less than $100 billion in 2000 (Masters. Their VAR model consisted of four variables.5 It has been indicated that while the recent (January 2009 to January 2011) commodity boom was driven by growing physical demand for commodities and globally accommodative monetary conditions. it is necessary to delve into some of these “financialisation of commodities (Chart 7). viz. empirically. trend chasing patterns appear to be better in capturing the developments in oil futures markets. Chart 6: Gross Market Value of Second. the effects of financialisation to change in global commodity prices (%) (of commodities) on commodity markets are difficult Source Jan Jan 07-'08 '09-'11 to isolate from price movements. 2 Vansteenkiste (2011) empirically tested the presence of speculation in commodity prices by estimating a markov-switching model with time- varying transition probabilities over the period January 1992 . global commodity prices. Notwithstanding such a phenomenal increase in Table 4: Contribution of identified shocks commodity derivatives.000 contracts in the second half of 2000.7 recent times.4 This could have been caused by the increased Wide volatility in commodity markets evoked co-movements between commodity markets and regulatory reactions in the US as well as in the EU. world industrial production. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY OTC markets.7 +122. 2011). Nevertheless. is viewed as a major factor behind the recent price spike. stock markets due to large fluctuations in the global In order to appreciate the future of the commodity economy during the financial crisis as well as by the economy. 20o8). the spectacular growth of commodity index funds. 5 Kawamoto and others (2011) estimated a vector auto-regression (VAR) model over the period January 2000 through January 2011 to analyze factors behind changes in global commodity prices. the market share of financial Chart 7: Correlation Coefficients between traders has more than doubled.April 2011 and found that for the earlier part of the sample (up to 2004) that fundamentals have been the key driving force behind oil price movements. 2008. 1990. This is reflected in increasing Total 100. Thus. 2011). there has been an increase in 4) Monetary policy shock +7. global stock prices.0 correlation between the returns from the respective indices. Thereafter. there is no 1) Physical demand for commodities -17. Source: Bank for International Settlement.

www.”7 Interestingly. Illus- tratively. Position Limits and Hedge Exemptions went on say: “Human nature tells us that those who are well-capitalized and looking for commodity market price exposure .S has evoked strong reactions from the Futures Industry Association (FIA) of the U. whose use is spreading and Trading Commission (CFTC) is in the process of uncontrollably. it flagged agricultural swaps as an important crisis. is a contributory parency to the swaps market and lowering the risks of factor in price volatility and food this market to the overall economy. (b) Increased trans- irrational but “herd-like” behaviour on the part of parency for physical commodity markets. explain everything. (e) enforcement. (b) clearing (such as. (d) data (such as. Besides. areas have been highlighted: (a) improved regulation ments of market participants in accordance with an for commodity financial markets. for example .AGRI COMMODITIES Agri-commodities are now In the US. Illustratively. tural Ministers. In the EU. The financialisation of writing rules to regulate the swaps marketplace. Besides. swaps.S. hedging instruments to provide better protection for the ities markets is the increased interdependence of poorest populations against excessive price volatility. was quite If such views capture the mood of global regulators. markets. …Over the last thirty years. new legislation was passed to increase and other companies to lower their risk by locking in the central clearing of OTC derivatives and ensure the the price of a commodity or an interest rate. 2011). it is evident that limits across OTC and exchange-traded derivatives. This is reflected in the growth of It is pertinent to remind ourselves of what French commodity index funds. deals through designated exchanges and facilities. position limits are already set in certain markets and position reporting (at least for the larger positions) has become a common practice. the US Commodity Futures derivatives. to extend the regulation to futures market. but enough people are saying this could happen that migration risk should not be relegated to the “boy who cried wolf” category” (Young. Contrarians.com / www. imposition of position limits in the U. The financialisation of agricultural risk mitigation functions. Chairman Gray Gensler. heightened risk as well as position limits for physical contracts. whose use is spreading markets. all other things being equal. 2011). argue that increased regulation “Agricultural commodities are now among the under- would only result in reducing liquidity in commodity lyings of financial derivatives. the G-20 has taken up issues relating commodities markets performed well during the 2008 to commodity price volatility and started focusing crisis and the commodity price movements of 2008 on energy and agricultural commodities. candid in his critique on derivatives as he said: the extent of regulation over the derivatives market in 6 The Dodd-Frank Act reviewed various aspects of derivative markets. Developed in the 1980s. official views have for the most vulnerable. Young. DATABANK . these markets. backed by less capital. the swaps market had remained unregulated to clarify the notion of inside information in the context and grew in size and complexity that far outstrips the of commodity markets. In the given scenario.indd 33 1/26/2012 1:40:28 AM . Mark D. or other financial index. even if it does not Dodd-Frank Act includes many important provisions and two overarching goals of reform: bringing trans.com/in/en A PwC & MCX Joint Endeavour 33 012-053_CIYB_2011_Exper's Views. help producers. The agricultural markets.mcxindia. along with the area where newer rules would be framed. (c) trading. (c) better investors in commodity markets (UNCTAD. currency robust regulation of central counterparties. in a recent address. even if it does not explain everything. No one is saying this is certain to happen. Four critical were simply an accurate reflection of the pricing senti. thereby impairing their price discovery and uncontrollably. Swap Data Repositories Registration Standards). 7 Interestingly. definitions of a Swap Dealer). on behalf of FIA. 2009). called swaps. clearing of insecurity for the most vulnerable. it is now seven times the size. (d) stronger An important impact of financialisation of commod. unregulated derivatives. and (f) position limits.as a hedge against expected inflation. The Act introduced swap trading and clearing requirements. CFTC lations” (Sarkozy. there is a dominant view that More recently. however. among the underlyings of financial because of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Swaps OTC markets and to introduce the notion of attempt added leverage to the financial system – with more risk to manipulate market. These include: (a) comprehensive Regulation of Swap Dealers & Major Swap Participants (such as. is a How do we see the future of regulation in the contributory factor in price volatility and food insecurity commodities market? Of course. the EU conducted a review of market abuse legislation however.NON-AGRI COMMODITIES DATABANK . Governance & Possible Limits on Ownership & Control). regulated futures market.6 In on Wall Street and played a central role in the financial particular. It opens the door to the manipu- firmed up against derivatives. choose a market without rigid limits. minimum capital requirements and aggregate position “While the crisis had many causes. 2009 CFTC Hearing on Price Discovery. in his testimony on the August 5. prevention and management of food crises.would. merchants.pwc. rather than a market with such limits. often President Sarkozy said in his remarks to G-20 Agricul- there is clamour for regulation of commodity markets.

because of the global financial and various other publications in India and abroad. (2008): “Exploding Commodity Prices. August 5. available at http://www. Mumbai.imf.cftc. IFAD. ECB Working Paper.org/ (2011): “What Has Caused the Surge in Global Commodity Prices and downloads/hearing080509_young. PARTHA RAY is currently D where does the reality lie? Going forward.C: & Ellis LLP on behalf of the Futures Industry Association”.Research-based policy analysis. before the CFTC Hearing on Price Discovery. Dr. Geneva: UNCTAD. (1953): “The Case for Flexible Exchange Rates”. Washington DC. general and of China in particular is going to stay. G-20 (2011): “Price Volatility in Food and Agricultural Markets: Policy com/g8-g20/g20/english/for-the-press/speeches/nicolas-sarkozy- Responses”.. Paul (2008): “Fuels on the hill”. the WTO. (2009): “Written Testimony of Mark D. The world of finan- cialisation of commodities will be no exception to it.org/external World Bank. Mumbai and energy guzzler. VoxEU. 1371. Bank of Japan Working Paper. Chicago: University of Chicago Sarkozy. Ke and Wei Xiong (2010): “The Financialisation of Commodities”. index.rbi. available at http://www. 27 and Sovereign Wealth Funds”. Gary (2011): “Financial Institutions in the New Regulatory Tang. there could be all-out stimulus measures on the part of the advanced countries and. there has been clamour for increased and more effective regulation of financial sector. Summers (1990): “The Noise Trader Approach to HLTF. available at www.g20-g8. faced with the possibility of another be more pervasive. No. G.org.foodsecurityportal. Constraints and Global Challenges”. increased demand for Oxford. the price of a commodity is often in commodity markets. Position Limits and Hedge Exemp- Kawamoto. In such hhe has been involved in applied a scenario. May. consequently.html IMF. voxeu. WFP. 2010. Environment: Opportunities. 11-E-3.OECD. pp. picture of archetypal emerging market as a metal or EEducated in Kolkata. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY the sublime world of undergraduate price theory to the About the Expert mundane and sleazy world of Bollywood villains’ hoarding.gov/PressRoom/SpeechesTestimony/ opagensler-90 Vansteenkiste. 2009 available at http://www. Washington D. Gokarn.futuresindustry. Vol. Mark D. IFPRI and the UN Shleifer. Kirkland September 2011. Ray may be reached at raypartha1@gmail. Calcutta. Finance”. June. in Positive Economics. Washington D. Michael (2008): “Testimony before the Committee on Friedman.C: Finance and Development. and L.pdf Copy. Consequently. regulatory efforts curbing speculative tendencies. V. March. 34 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. 19-33. Journal of Economic Perspectives. World Bank (2011): Global Economic Prospects. A. and us that the contribution of the emerging markets in th the Reserve Bank of India. M. Helbling. available at http://rbidocs. general and commodities derivative market is going to At the same time. International Monetary Fund (2011): World Economic Outlook. Policy Report including contributions by FAO. Nevertheless. 20 May. Inaugural Address at Special Conference in honour of Dr. Cheng (2008): “Riding a Wave”. Never.indd 34 1/26/2012 1:40:29 AM . adresses-a-speech-to-the-g20.org/index. in Essays Homeland Security and Governmental Affairs”. 20 June. In Institute of Management. pp. Takeshi Kimura. there are elements of truth in the popular eeconomic research and policy- mmaking for nearly two decades. this question is PProfessor of Economics at the Indian assuming importance. the seen as the outcome of the villains’ hoarding actions buoyancy of commodity markets will crucially depend on and selling commodities at a premium and selling in the the durability of global economic recovery and on how the black market was seen as the ultimate evil act.com crisis. Young. Dr Ray has contributed extensively on issues related to commodities from the emerging markets is here to the financial sector and monetary policy in professional journals stay.1402. References Calvo. Young. T. available at www. Nicholas (2011): Speech at the Opening of the meeting of G20 Press. US Senate.voxeu. markets and possibility of excess global liquidity – all theless. increased demand for commodities from emerging which is function of a set of fairly standard factors. Which way now? there could be considerable expansion in global liquidity. No. The New York Times. 157-203. Lax Monetary Policy. The story of the post-2008 growth trajectory tells HHaving worked in the International MMonetary Fund.in/rdocs/ (2011): Report of the Global Commodities Forum 2011 -Advanced Speeches/PDFs/TPRIPR261010. vox . in the classic image of any Bollywood movies of are going to interact and determine the shape of things the 1950s and 1960s. and K. Agriculture Ministers on 22 June 2011. In the immediate future. recession. DR. Undergraduate price theory teaches us that that price of Thus. Mumbai United Nations Conference of Trade and Development (UNCTAD) on October 26. Kentaro Morishita and Masato Higashi tions.php?q=node/1244 Masters. Mercer-Blackman. 4(2). a commodity is determined by its supply and demand. Takuji.php?q=node/5859 available at http://www. Gensler. UNCTAD. the World Bank. From Euro-area debt crisis gets resolved in the days to come. Krugman.pdf Strengthened Cross-Market Linkage?”. 2 June 2011. Kirit Parikh at IGIDR.org/ Remarks of CFTC Chairman at the Georgetown University Conference.org. available at http://www. Isabel (2011): “What Is Driving Oil Futures Prices?: Fundamentals Versus Speculation”. Subir (2010): “The Price of Protein”.

mcxindia. DATABANK .AGRI COMMODITIES www.pwc.com / www.NON-AGRI COMMODITIES DATABANK .com/in/en A PwC & MCX Joint Endeavour 35 012-053_CIYB_2011_Exper's Views.indd 35 1/26/2012 1:40:31 AM .

the world economy. However. etc. The financial crisis of Different reasons can be attributed to the formation 2008 had led to a recession in the global of economic cycles: economy. when the world economy enters the “recovery mode”. as commodity prices have become increasingly correlated to financial assets and more used for portfolio diversification. and peak. and Sanjoy Majumder. This is likely to lead to a contagion impact worldwide and. studies have shown that the commodity cycle is positively correlated to the economic cycle. Associate Director. there is no definitive evidence demonstrating that economic cycles cause commodity cycles or vice-versa. their sovereign debt obligations. commodity prices have been significantly higher than expected. Over the last five years. it has been increasingly C difficult to predict economic cycles nowadays with ommodities have always been an important increasing integration among economies globally and a cog in economic or business cycles of plethora of external factors impacting the same. in the midst of these developments. At a time and exchange policy. prompting governments to announce bailout • Supply shocks due to a disturbance in production packages and policies to help businesses sustain. The question that arises is: whether commodity prices have become immune to economic cycles and a new world where the linkages between markets and economic cycles have weakened consid- erably has emerged. It may be still early to arrive at a definitive conclusion. Senior Consultant. resulting from factors including natural disasters.indd 36 1/26/2012 1:40:32 AM . as exhibited in an economic expansion and economic contraction and are generally divided into a recession. Interestingly. However. • Demand from the private sector. the relationship between economic and commodity cycles has been weakening. However. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Commodity cycles: Follow or cause economic cycles By Robin Roy. around the globe. Reasons for economic and commodity cycles and their relationship Economic cycles refer to the cyclicality in an economy. fluctuations in prices of raw were significantly impacted by the recession. expansion. a look back at history and analysis of the performance of commodities vis-à-vis the real economy can throw some interesting insights. 36 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. PwC Historically. While the developed economies climate changes. in turn. in the current economic cycle. including changes the fear of “double-dip recession” lurks on the horizon. technological advances. affect asset prices and commodity markets. trough. Financial Services. the material. emerging economies like India and China — despite • Demand variation resulting from economic having encountered a slowdown in the real economy (consumption) needs including monetary easing — managed to grow at a much faster rate. in consumer spending and preference of private as several European economies are unable to service investments. Studies have shown that economic cycles are generally of 42-54 months in duration.

has led to economic recession (e. Source: www. 54 percent for steel. lead to less speculation. (including commodities). for zinc. leading to increased supply. and 30 percent for crude oil. we can divide them into some distinct in doldrums. thus pushing iron ore and coking coal as mining companies failed to prices of commodities. 113 percent the US in the 1980s). with major factor in their co-movement.com / www. However.indd 37 2/9/2012 12:03:13 PM . Comparatively higher Precious Metals: These are naturally occurring rare returns on bonds (a competitive asset class) could metals of high economic value such as gold and silver.goldprice. In countries like India and China. than other categories (commodities). IMF reported that cycles follow economic cycles or vice-versa has been China’s share of overall growth in global consumption always a point of debate. As demand for base metals increases. Brazil and others capacities through investing with an increase in real tightened their monetary policies and. it was still above the long-term average of around US $20-25. which in liquidity in the markets turn will lead to a drop in prices. Base Metals: Studies have shown that base metals (metals that oxidize or corrode easily) such as iron. Gold prices have economic activity has been robust despite manifold risen significantly in the last ten years. though there have was massive – 51 percent for copper. structure demand in the period of 2004-2008 as well as dependent countries under considerable inflation withdrawal of investment funds from financial markets pressure. However.NON-AGRI COMMODITIES DATABANK . even the most increases in commodity prices — something that leads bullish forecasts have not been able to anticipate the to the conclusion that high commodity prices will be the extent of price rise! Other precious metals have followed trend in the near future. and a shortage in and capital expenditures of enterprises. Studies have shown non-OECD Asia (including China and India) accounting that such co-movements that were more prominent in for 43 percent of that increase. thus impacting the overall producers begin adding capacities to meet the growing global economy. as there is a gestation period in Studies have shown that the formation of commodity attaining the enhanced capacities. reduced interest rates. India. the Chart 1: Gold Prices relation between oil prices and the economy at large seems to be weakening.AGRI COMMODITIES Transmission of the economic cycle happens copper and lead follow a 20-year cycle — the latest cycle through international trade and financial markets started in 2001. The demand for actual gold has continued hardening of commodity prices. as the world economy is verticals. 1970s and 1980s demonstrated a declining trend in Similarly. 110 percent for lead. DATABANK . 48 percent for been cases where supply shocks due to a particular aluminium. in turn reflected in decreased This category of assets behaves in a very different way commodity prices. suit. the central banks and investors find it a categories. The reserve to production ratio has not improved over the years and the cost of production is increasing with time as exploration costs rise. coupled with the increasing demand from emerging economies and speculation in financial markets. commodity. thus.org www. the heightened gap cycles is positively correlated to the economic cycle and between demand and supply leads to increased prices. While there was a considerable decline in 2009. The US Energy The boom in commodity prices is also a function Information Administration has forecasted a 47 percent of real interest rates in the economy. However. say oil. which in turn is a increase in global demand from 2003 to 2030. the increases in its commodities have had a direct impact on the world price have outraced the actual physical demand as economy (oil supply shocks brought recession in developed economies like the USA) since 1990s.mcxindia. The upward co-movement in supply due to overcapacity formed during China’s infra- commodity prices is likely to place commodity import. Commodity producers will try to augment as economies like China. The major reason is that gold is looked upon as If we take a close look at individual commodity a substitute for cash and. higher of the current decade. in particular. led to an upward cycle in oil prices in the last decade. 87 percent for nickel. This.com/in/en A PwC & MCX Joint Endeavour 37 012-053_CIYB_2011_Exper's Views. demand for steel was driven by arising from government expenditure on infrastructure China (Beijing Olympics). is mainly due to the cyclical demand of commodities In the 2004-2008 cycle.g. the downturn in prices of base metals 1990s and again became prominent in the beginning can be explained from contraction of demand. as follows: strengthened over the years due to increased demand Energy/Oil: While the prices of oil-centric energy from China and India.pwc. 86 percent for tin. demand. Economic boom has generally of industrial commodities between 2002 and 2005 led to a rise in commodity prices. helping us analyze the key factors in safe investment haven. whether commodity respond to the rise in demand in time.

The developing countries like India and China have regis. will continue to face signif- the cost of producing commodities has risen manifold icant fluctuations in consumer and wholesale prices and integration of financial markets has also become depending on the behaviour of global commodity coherent which can factor in any impending supply/ prices. The price movement of commodities was much Agri-commodities: The behaviour of agricultural more dependent on the actual supply and demand. at an individual or this. Demand for certain commodities such as oil has aggregate level. the relationship between the The inflation models that work in the US perform movement of commodity prices and that of other poorly in Germany or Japan. significantly increased in emerging countries like China domestic consumers and wholesale price levels. commodity price fluctuations have an impact on unit manufacturing costs and. tations. perhaps. the actual supply-demand conundrum. Food cycles are generally linked to drought effective instrument for reducing portfolio risk through and flood cycles and the impact of monsoon. especially diversification. even on labour Commodity prices and other costs. concerned about the actual supply-demand scenario For example. The increase in commodity prices may lead to financial assets higher wages. albeit between commodity prices and the equity and debt slightly. Evidence of this correlation can be seen ities has not kept pace with the increase in demand as in the aftermath the financial crisis of 2008. S&P agricultural index. high prices have actually hurt. In fact. Productivity of agricultural commod. the real physical demand for gold. commodities related to food has been somewhat However. phenomenon of oil prices peaking at $147 in early tered unprecedented growth. markets also look at in commodity markets has been responsible for the productivity. Chart 3: OPEC quota and crude oil Chart 2: Food Prices Index quarterly production. So is the case with metals. However. as Impact of commodity prices on such. A study by Perry in 1975 financial assets has dramatically changed vis-à-vis found that import prices and the GDP deflator affected 38 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. however it may not be true at all times. In the last decade. are limited. demand patterns and “financialisation of commodities” and that has led world politics. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY instruments like exchange-traded funds (ETFs) gain in the previous decades. as economic Economies like India. Besides. co-movement popularity. Source: FAO and PwC analysis Source: nergy Information Administration. This shows markets was hardly evident. though in the past few years the trend putting money on commodity index futures are less seems to have shifted in favour of agri-commodities. The past decade. indirect demand shocks impacting commodities. Investors the last 30 years. government policies. which is heavily dependent activities in these countries have increased enormously. Several reasons can be attributed to of change of commodity prices. Studies have shown that the agricultural to increasing correlation of commodity prices with composite index has always underperformed markets in asset markets such as stocks and bonds. even though liquid the intrinsic difference between precious metals and futures contracts on commodities were traded. on commodities like oil. The entry of large financial investors for a country like India. Apart from the direct impact on prices. is directly linked to importing units. has seen an economic variables unprecedented rise in commodity prices and commod. after the equity market crash in 2000.indd 38 2/9/2012 12:03:15 PM . has been underperforming the Dow rebalancing their portfolios based on market expec- index since 1975. or so. Prior to 2000. and India. a composite of all than producers or consumers as they are constantly agri-commodities. The rate to some extent. in countries like 2008 and then falling back to $48 in 2009 had more India supply chain issues and speculation in markets to do with a downturn in equity markets rather than have aggravated the problem. USA and study by Jean Lapierre Commodities are mostly natural resources and. other commodities. the different from other sets including metals and energy trend changed as commodities were thought of an commodities. Commodity price movements have a significant impact ities’ relationship with economic cycles have weakened on macroeconomic variables of the economy.

The PwC report ‘World in m market feasibility studies. As the US dollar declines. demand from China and India has been keeping A study by two Indian economists and a chart thereof commodity prices on the higher side. making prediction on improving agricultural productivity. Calcutta. Prior to joining PwC. DATABANK .majumder@in. Globally. such as Germany. In his earlier job. WIDER papers WP88). www. which declined important in this period. Sachs in 1979 confirmed this ROBIN ROY. Prior to tha that. His experience than the US. even recession.com the potential to gain. Financial S S Services. given le leading a team of analysts responsible for financial planning. Senior Consultant. S Services. have (in forex assets) seek higher yields from alternative been adopting a “wait and watch” monetary policy. The possible reason can be that labour eencompasses a broad range of financial services segments ssuch as banking. Mr Roy also served as managing director of a financial services company involved in insurance and other financial products. asset classes such as commodities and vice versa. he worked more centralised in the US (World Institute for Devel. Mr other emerging countries. As economies far clearly demonstrates this. it will impact the global economy leading adopt a tight monetary policy in order to reduce money to a slowdown and if sustained.com / www. industrial activity S Sanjoy Majumder is currently Senior Consultant. Mr Roy’s markets are different. along vis-à-vis international commodity prices determines with moderate fuel inflation with the prices having the actual commodity prices. The underlying model explained a far smaller A postgraduate from IIM Kozhikode. Oil prices have increased and wide are becoming increasingly integrated globally. much more in USD terms than in euros. cycles (reflecting the real economy) has been on a Commodity prices have an impact on currency divergent track in the last 5 years is more becoming too. PwC. president of retail banking & financial services in a foreign bank being an executive vice preside Besides. interest rates and money supply.pwc.com Several studies have shown that the change in commodity prices has a causal relationship with SANJOY MAJUMDER. conclusion. If there trend and this also has contributed to inflating prices. in the current world economy. R result. have a in India. He has more than 11 years of experience with aaround eight years in the area of financial and risk analytics. The growing linkage between commod. business research and the upward pressure on the relative prices of these risk management management. business process re-engineering 2050’ points out that countries that are heavy users aand equity research. asset management and insurance. to the US dollar. A postgraduate from IIM Calcutta and a several macro-economic indicators such as GDP. on an average) has led to a substantial increase in the demand for commodities related to food items and Economic cycles may lead to energy. He has been involved in cost-of living escalator provisions.pwc. commodity prices. PwC. the cadence with demand yet to moderate. to commodities. prompting the disturbances or a substantial dip in production of country’s central bank. led to inflation. there is national business cycles. India In countries like India. bbachelor in engineering from Jadavpur University. PwC. Robin Roy is currently proportion of wage inflation in Germany and Japan AAssociate Director. employment and wages.indd 39 2/9/2012 12:03:15 PM . PwC. but that the prices had no About the Experts such impact in Japan.NON-AGRI COMMODITIES DATABANK . covering strategy and pprocess improvement areas. in banks in various capacities for 20 years. supply-side constraints and movement of commodity cycles and economic have kept prices on the upside.mcxindia. Mr Majumder was of energy and commodity as inputs may lose out. the last position opment Economic Research.roy@in. Long-term contracts do not ccore experience has been in the corporate. India and US investment banking firm covering technology. and currency movements. and bargaining is a number of banking-related projects. consumers extend from one year to the next. Financial Services. Financial Services. Fluctuations in commodity prices lead to infla- tionary and deflationary trends in national and inter. there are no formal aand multi-channel banking models. as the developed a strengthening of commodity prices as investors nations. However. pprofitability analysis. country price level. SME. newspapers and magazines in India. cost analysis.com/in/en A PwC & MCX Joint Endeavour 39 012-053_CIYB_2011_Exper's Views. The strong (measured by inverse of asymptotic trade) by appro- growth that we have witnessed in the last few years priate foreign price level and deflates by the home (GDP growth during 2005-2010 was over 8 percent. is a supply shock arising from international supply This has. the Reserve Bank of India. indicating countries like India are being increasingly impacted by that USD has depreciated vis-à-vis the euro. as. governments. biotech and semiconductor firms. cumulatively. Despite this we have not paid enough focus commodity cycles. The prices are generally negatively correlated co-related to financial markets. In the past couple of years. It is extremely difficult to predict economic cycles on ities and financial markets has led to a speculation the basis of commodity price indicators alone. A real effective exchange jumped more than 40 percent for petrol and around rate (REER) adjusts nominal effective exchange rate 20 percent for diesel in the past year. the rupee-dollar equation has had an average inflation of more than 9 percent measured by the real effective exchange rate (REER) with food inflation rising to around 17-18 percent.pwc.AGRI COMMODITIES wage behaviour in Germany. He has authored several articles in leading strong voice in determining labour wages. he was doing equity research in different areas for a commodities due to rapid growth in China. while OECD countries have Majumder may be reached at sanjoy. Financial and capital expenditures. this has not been much effective. In supply. Associate Director. Mr Roy may be reached at robin. yet to recover fully from the recession.

and is the direct consequence of a long-term Chinese government programme to promote the development of domestic producing and consuming industries. government efforts consumer markets for goods and services. It also has become a major producer and user of silver. It may become a major market at some point in the near future. How Chinese market participants. after decades in which the government held back the Chinese gold market. Managing Director.indd 40 1/26/2012 1:40:37 AM . We personally 40 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views.6 million ounces in 2000. and the largest market for gold in fabricated products. one of the largest refiners of gold from scrap. the Chinese government has taken under Deng Xiaoping in the late 1970s. This is in contrast to the 99. this year it will be around 21. Most of this has occurred within the past decade. broader programme to encourage economic devel. China has become the major producer and consumer of gold. including jewellery and the use of gold in electronic compo- nents. While the fruits of these efforts have only truly opment across industries. at present. C hina has become the world’s largest gold mine producer. there is a strong impetus to making 99. Christian. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY China's pre-eminence in the global gold market By Jeffrey M. and to to foster such industrial development.8 million ounces. an effective and efficient approach towards working Importantly. in stark contrast fabricating industries within China. refining.99 per cent pure gold (4-9s) good delivery standard in Shanghai. it will be around 11. Combined fabrication and investment demand for gold was 7. This is in line with China's rise to pre-eminence across industrial sectors. CPM Group China has become the largest producer and consumer of gold in recent years. to develop domestic emerged over the past decade.50 per cent good delivery gold standard in the London interbank market and the New York Commodities Exchange.8 million ounces. As part of economic reforms initiated by the Chinese government this programme. This is part of a to government postures in some other countries. For example. and strengthen domestic markets for gold. the government has actively with industrial groups and companies to promote and encouraged developing gold mining. As recently as 1996 Chinese mine production of gold was around 4 million ounces a year. date back to the based on domestic economic conditions. and government agencies approach this almost inevitable transition will be critical to gold market participants around the world. exchanges. including seek to increase the portion of the Chinese economy moves towards effective regulations. This year. as well as domestic markets tied into international markets for these metals.

In the early 1990s.com/in/en A PwC & MCX Joint Endeavour 41 012-053_CIYB_2011_Exper's Views. in every aspect from manufac. The setbacks and reversions. economic. Recognising the restraints on technology and capital within the country. the rise of China and India The government organisation we worked with at that as major world economic agents over the past two time pointed out that the government envisioned such decades and into the future represents a return to moves to be spread over three or more decades.9 per cent of global economic output. the conversion of agrarian farming into fiscal nightmares cannot be ignored as a lesson patterns into more mechanised and efficient agricul- that has gone unlearned in other parts of the world. Mine production Chinese gold mining has undergone a dramatic trans- formation in the last 50 years. and moves toward a convertible most people around the world. 2007 China was producing 8.pwc. In the ultra-long run. but now they have embraced managed market economy and the political disarray the concept that economic development.6 million ounces The revelation that in 1820 China accounted for of gold in recoverable resources by 2009. and other benefits for most members Indeed. China’s gold production is estimated to be 10. the Chinese government opened gold exploration and development to foreign companies in 1994.com / www. relatively low-cost skilled labour. New primary gold mines are starting up. direst global economic and political scenarios.9 million ounces in 2010. as the effects in the early part of this century were closely in line of the Industrial Revolution took hold. sometimes lasting decades. the Chinese government de-centralised control over production. and China to Ministry of Industry and Information Technology and India combined shared a half of world economic figures.indd 41 1/26/2012 1:40:40 AM . DATABANK . But of the country has not been systematically explored www. The growth in Chinese has been facilitated by production accelerated after that.7 million ounces a year. China and India with those under discussion a full two decades earlier. replacing South Africa as the world’s largest gold producing country.0 million ounces by 1984 and then to around China’s gold 5. while existing mines continue expanding. consumer production to grow at a compounded annual growth goods. this historical fact has been driven home to silver market reforms. and is forecast at 11. except in the the world economy. and services. and technological advances enabled Chinese gold mine turing to consumption of raw materials.5 per cent from 1990 through 2007. Expectations are that reserves and resources activity might have surprised many European and are many times the proven levels. however.0 million ounces a year by the mining expansion late 1990s. Europe and North America has been interesting to see how the reforms initiated grew rapidly from the 1830s onwards. in the early 1980s for the Chinese government. stepped-up exploration as the quickened pace of economic of its geological reforms in the country took hold. China had a total of 200. resources. country is becoming a much more important part of It is unlikely to be reversed. and historical 1820. the emergence of China as a major gold of society. rising from around 250. By resources. tural operations.AGRI COMMODITIES worked on a multi-volume report related to gold and by now. opted out of the industrialisation process for most of The contrast between such an effectively run and the ensuing 170 years. according 32. rate of 8. industriali- that has turned the European and US governments sation. projected 2030. and other trends all have tremendous Growing in economic clout social.000 ounces a year between 1950 and 1959 to around 2. given that much North American audiences just a few years ago. This is a long-term process that can suffer market is part of a much larger economic trend. Table 1 shows the relative contributions of the China’s gold mining expansion has been facili- top 10 economies to global economic output in three tated by stepped-up exploration of its geological periods: 2009.NON-AGRI COMMODITIES DATABANK . urbanisation. It historically typical patterns.mcxindia.8 million ounces in 2011. Increases in the flow of private capital. yuan.

There are no official statistics on scrap gold medical applications in China in 2011.430 ounces of gold will be used in dental and boomed. consumption of gold jewellery in China operating deposits.9 per cent from 2010 levels. Chinese gold jewellery consumption remained firm while globally gold jewellery demand was declining during the global financial crisis in 2008 and 2009. China’s gold jewellery market began to take off in the late 1980s. coins.indd 42 1/26/2012 1:40:41 AM . cobalt. but dental and gold jewellery became more prevalent in urban China.3 per cent of global gold fabrication discour¬aged. It is estimated that Chinese citizens have always been active gold fabrication demand in 2010 stood at 13. even at known and In 2010. for gold and other resources and. Gold also is used in dental alloys in China. markets and banks were viewed with greater suspicion Alloys based on nickel. recovery in China. Chinese investment demand is at a compounded annual growth rate of 7.3 million ounces in 2011. Chinese net exports of gold-containing jewellery and jewellery pieces. around 17. Gold jewellery demand is mining companies tend to do.2 per cent. Fabrication demand is forecast to rise further to 14. in gross weight.2 million ounces.5 per cent.4 million ounces in 2009. As the possession of were commonly used in the past. There is strong demand within China for physical gold in the form of bars.475 ounces in 2007. surpassing India in recent years. Demand for gold jewellery ounces in 2000 to 730. As in many parts of Asia.2 per cent from 3. rate of 68. Secondary supply Use of gold in electronics grew at a com¬pounded Gold jewellery is the largest source of scrap gold in annual growth rate of 9. and dental and medical sectors.7 per cent to 7. the practice is not necessarily to is estimated to have risen by 9. and other base metals by investors than they are today. as it is worldwide. China’s trading.3 per cent to 3. electron¬ics. medical use of gold is now rising in China.30.5 million China’s gold fabrication demand comes from jewellery ounces.3 million ounces in 2011. up 8. fuelled by continued investor interest for gold (the most. and now rose in the 1980s and early 1990s. when the central government started allowing greater amounts of private sector gold to be allocated to jewellery man¬ufacturing. CPM Group estimates that Chinese secondary gold recovery is currently happening at Investment demand around 3.4 per cent in 2008 and 26. A large number Fabrication demand of Chinese investors prefer physical gold to paper China also has become the world’s largest con¬sumer investments because of its tan-gibility and ease of of gold. declined by 10.1-3. forecast to reach 13.6 million ounces Its annual gold consumption rose from 2001 to 2010 in 2010.3 million ounces a year.1 million investors. it was limited for a few decades from 1949 into the 1980s by efforts by the Communist government to discourage gold jewellery investment as well as per¬sonal consumption of non-essential goods. in China gold jewellery is both a lux¬ury good used for adornment and a form of gold investment and savings. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY demand that year. In 2011.0 per cent in 2008 and 6. even when gold ownership was officially ounces. Chinese investment demand for gold — in both jewellery and investment demand has grown at a compounded annual growth categories — has been growing rapidly in recent years. Chinese gold jewellery fabrica¬tion demand managed to grow 8. There was a very 42 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. from 1949 to 2000.2 per cent year-on- drill and prove reserves and resources as western year to 12. Perhaps the business of recovering gold from scrap jewellery 71. reaching 5. While jewellery has been an important part of China’s gold market for centuries. in line with the rest of the world). Due to robust sales of jewellery in domes¬tic cities. when China’s roughly one million ounces a year is used in these economy started taking off and at a time when financial products. forecast to increase by 34.922 China. Over the past four years. amid high inflation.3 per cent in 2009 despite the declines in exports of gold jewellery. and medals.

and exported the by-product silver and gold As a result. statistics regard¬ing gold scrap recovery after it was recovered from the concentrates. agricultural. it is not just China that is enjoying an economic As alluded to above. consequently It is the third largest silver producing nation. consequently.com / www. the data on gold secondary International Monetary Fund. CHRISTIAN. China has available guesses in the market on demand trends become a net importer of refined silver once more. At been executing a very effective industrial programme that time there were significant shifts in silver use to develop the gold and silver mining. these usage patterns western market. metals.NON-AGRI COMMODITIES DATABANK . Mr. Additionally. lead. or one of the are billions of people elsewhere who have been let largest. It is projected countries. This shift to net imports gold market. As decade. there the country has become the largest. CPM Group provides research. Gold is a secretive market around the world. demand estimates for the Chinese market for the It does not reflect a decline in domestic production. consulting. their economies. and numerous governments. Based on CPM Group’s involvement shifted again and there were strong increases in silver as advisors to Chinese agencies. ounces a year in the early 1980s to more than 104 India has participated strongly in this trend. its silver use although not as dynamically as has China. witnessing its demand has moved to a pre-eminent position over the past for gold. S investment banking. In 1986. I wrote in my 2006 book. from Brazil and Argentina to Russia to that China will use around 177 million ounces of silver countries in central and eastern Europe. after six years with Goldman Sachs and its 1 ccommodities trading arm J. As a result. there also was a large increase in silver (This article is derived from a special chapter on refined from base metals concentrates from both the Chinese gold market in CPM Group’s Gold Yearbook domestic and foreign copper. a trend that is unlikely and demand statistics into its model of the global to reverse in the near future. and demand have been particularly unreliable in the In the past five years. and the ability to gather credible data on gold demand and scrap refining within China was at this time. actually Not just gold? Finally. million ounces projected in 2011.AGRI COMMODITIES active informal market for gold within China during About the Expert those years. while governments of in domestic silver use in that industry. and other commodities increasing. if not the largest. there was a massive wave of gold investment aadvisor on precious metals and commodities since the demand within China.com/in/en A PwC & MCX Joint Endeavour 43 012-053_CIYB_2011_Exper's Views. The differences between the growth rates of China China was a net exporter of silver for most of the and those of other countries reflect a number of period from 1949 to the 1990s. it is not just gold in which China renaissance and. exports began. over the past two increased silver production from around 2 million decades. Managing Director and 1990s. Christian larger volumes of gold being bought in both bar and founded CPM Group through a management buyout of fo jewellery form than the high volumes of gold demand what was the Commodities Research Group at Goldman w over the past few years. In the early JJEFFREY M. which led to a reduction silver using industries in China. before resuming the start of this essay. and m Information institutional and individuals with exposure to precious and base metals. With the unleashing of its domestic economy. the gold market for many years.mcxindia. which exists even today. thus. which in fact may have involved 1970s. to become investors and consumers. Annual net imports have risen to around been able to integrate Chinese gold market supply 100 million ounces in 2010. in advance of a large official devaluation of the F Founder of CPM Group. Now. Other is one of the largest. ounces in investment products in 2011. Not just China. Sachs then. out of their economic cages and have been freed China also is excelling in silver supply and demand. The Chinese refiners wanted the base hampered until recent years by government actions. within China were not accurate. and commodity in management services to corporations. The Chinese government has as a large net exporter from 2001 through 2006. governments.pwc. other countries have been less effective in promoting large amounts of silver were not purchased for use in the growth of these very profitable industries within film and paper any longer and. DATABANK . producer and consumer of many goods. As a result. Mr. He has advised the World Bank. has been a prominent analyst and yuan. the United Nations.com supply and demand trends within China have lagged the growth of the market. silver. and gold and in photography in China.indd 43 1/26/2012 1:40:43 AM . past 10 years. also are in fabricated products and buy another 15 million experiencing strong growth. It became a small net factors including one important factor mentioned at importer for a time in the late 1990s. by developing fabrication and investment comes at a time of increased mine and refined output. Christian may be reached at jchristian@cpmgroup. Commodities Rising. having boosting demand for these metals. While China has been an important part of the global and energy commodities. Aron & Company. asset management. and zinc mines 2011) www. it was clear that the demand from other industries. CPM Group has now since 2006.

regulators have moved too far. compromise the potential for unified financial Frank”) is intended to reduce the riskiest aspects regulation among nation-states. by seeking delays of years in Dodd-Frank’s implemen- the wholly unregulated worldwide over-the. Wall Street argues that consistent. Thus. ironi- Street Reform and Consumer Protection Act (“Dodd. University of Maryland The US Dodd-Frank Act is intended to reduce the riskiest aspects of previously unregulated derivatives trading by increasing capital and transparency requirements and requiring mandatory clearing and exchange-like trading. interna. tional regulation will keep traders from fleeing the US Moreover. that followed the Lehman Brothers bankruptcy. counter (“OTC”) derivatives market are still These calls for delay of Dodd-Frank court a repeat shaking the global economy. cally. These advocates are thus shockwave unleashed. This Yet. mandatory clearing. If properly implemented. and value) remains undercapitalized and opaque for years exchange-like trading. immediate implementation of robust implementing regulation of derivatives products under Dodd-Frank regulations would facilitate. Dodd. the extraterritorial effect of Dodd-Frank 44 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. another economic downturn caused. If the US share of of derivatives trading through increased capital derivatives trading (estimated at $300 trillion notional requirements. by the European sovereign debt crisis. T he reverberations of the 2008 economic to foreign jurisdictions. universal regulatory standards. are able to act in unison with increasing number of countries develop and implement the US. transparency. could the world’s $600 trillion notional value market from lead to an economic collapse far worse than the one being the prime engine of systemic risk. The Dodd-Frank Wall of systemic worldwide economic disaster and. representatives for the world’s large banking is because countries are running out of remedies and interests now insist that Congress and US financial money to prevent a repeat of the Great Depression. Because major non-US regulators have tended to model their regulatory frameworks after the basic statutory premises of Dodd-Frank.indd 44 1/26/2012 1:40:44 AM . US implementation should proceed promptly and not await the several years for worldwide uniformity. and Michael Vesely. University of Maryland. rather than Dodd-Frank. immediate implementation in the US of robust Dodd-Frank regulations should likewise facilitate universal regulatory standards. this kind of reliance on fully Dodd-Frank until non-US regulating entities. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Re-writing the rules of the game: Evolving contours of global regulatory regimes to govern derivatives By Michael Greenberger. tation while awaiting worldwide action. in large part. Law School Professor. especially implemented US templates is likely to continue as an the European Union. for Frank would remove the US portion (about one-half) of example. to come. Non-US In order to check this perceived unnecessary regulators have tended to model their own deriva- expedition these banks and their allies have urged that tives regulation after the basic regulatory premises US regulatory agencies delay the implementation of underlying Dodd-Frank. financial reform models. jeopardize. thereby preventing worldwide systemic risk. too fast in passing and Further. JD.

At the Passage of Dodd-Frank heart of this meltdown were the naked credit default In July 2010. to protect the subprime investments. develop internal practices that comply with US trading Moreover. “To promote the financial stability of the United ments essentially provided insurance on subprime States by improving accountability and transparency in mortgage risk to those who did not even hold the financial system. the problems associated with deregu- requirements. in and of itself.com/in/en A PwC & MCX Joint Endeavour 45 012-053_CIYB_2011_Exper's Views. DATABANK . were called upon to make the insurers whole by paying tives traders who wish to participate in US markets to them trillions of dollars. whose preamble pronounces its purpose as: ipants to unprecedented levels of risk. the unity of financial regulations.indd 45 1/26/2012 1:40:46 AM . underpin there must be an effective regulatory regime The financial world pre-Dodd-Frank Act to address all types of derivatives and not just CDS.mcxindia. global capital to make the insurance payments. instruments that exposed market partic. entitled ‘Wall by paying premiums as low a one–half per cent of Street Transparency and Accountability’. taxpayers standards for derivatives. the US Congress passed the Dodd-Frank swaps (CDS).NON-AGRI COMMODITIES DATABANK . to end “too big to fail”.com / www. they became exposed to have to comply with Dodd-Frank requirements if they and defaulted on tens of thousands of other deriva- wish to operate in US financial markets—so that any tives-based and undercapitalized opaque obligations. These instru. bill. The “insurers” did not have the to regulate the derivatives market. tend to establish uniform. delay in its implementation threatens to fractionalize.” (defaulting mortgage investments owned by others) Title VII of the Dodd-Frank Act. edness of all derivatives instruments and. It is hardly disputed that unregulated derivatives were a primary cause of the 2008 financial crisis. is designed the amount insured. [and] to protect recover 100 cents of the dollar of the “insured risk” consumers from abusive financial services practices. When financial institutions were unable to a cross-jurisdictional regulatory regime—global banks meet their CDS obligations.AGRI COMMODITIES will. In this respect.pwc. These cascading defaults revealed the interconnect- rather than ensure. further. Dodd-Frank functions as alone. even if the financial trader is located in a lated markets were not constrained to naked CDS foreign country. It generally www. Dodd-Frank requires deriva. permitting these investors to American taxpayer by ending bailouts.

” constructed around a philosophical framework that Going forward. collateralisation. the US should continue to develop the their operations in order to prepare for the upcoming necessary regulations as quickly as is feasible and proposed requirements. commerce derivative contracts should be traded on exchanges of the United States” or contravene such Dodd-Frank or electronic trading platforms… and cleared through regulations that prevent evasion of the statute’s provi- central counterparties by end-2012…. Global coordination under G20 Section 722(d) of the Act states that the statute applies The nations at the Pittsburgh G-20 summit of to swaps that either “have a direct and significant September 2009 agreed that “all standardized OTC connection with activities in. For example. any implementing Dodd-Frank. reporting. Although the FSB’s commitment to financial reform is encouraging. but in that previously unregulated market. many Wall rely on Dodd-Frank’s sweeping extraterritorial scope to Street firms are already establishing frameworks that establish international standards to prevent a repeat will allow them to comply with clearing and exchange. the delays in establishing worldwide Moving forward with Dodd-Frank financial regulations mean that implementation is a Despite the threat of underfunding the relevant long way off. trading mandates. This title is still urged “substantial concrete steps.indd 46 1/26/2012 1:40:47 AM .” tions. Major market participants have already begun altering Instead. and transparency. sions. with opaque and under-capitalized trading practices. the statute has already delay in US financial reform leaves the global economy increased the power of regulators over the market and vulnerable to the demonstrated risks associated is already helping prevent systemic economic failures. the FSB will continue to highlight requires: adequate capitalisation by large derivatives areas where “differences in approaches may foster dealers and end-users. 46 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. Therefore. of the systemic economic deterioration of 2008. and trading requirements reach an end-2012 goal for implementing reforms.” In April 2011. Dodd-Frank establishes international standards for the regulation of derivative transactions. Dodd-Frank should require non-US the Financial Stability Board (FSB) issued a report banks that transact swaps with US counterparties to indicating that some jurisdictions may not be able to abide by Dodd-Frank’s regulatory requirements. Given that the US market constitutes regulatory agencies and delays in those agencies half the world’s $600 trillion derivatives market. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY imposes clearing. Again. or effect on. clearing for almost all transac. or facilitate opportunities for regulatory arbitrage.

Delaying Dodd-Frank will delay its derivatives in Asia. this data with regulators. because suggesting prudence in large banks. swaps significantly different from one another. Regulation will likely proceed on a substantial extraterritorial and unifying effect. participants are going to infuse much tives or all derivatives.mcxindia. it is already being institutional investors (FIIs) into the intending a vote on a final draft followed in numerous parts commodities market. to regulate derivatives as mutual funds. Frank. This is very soon. exchange- a proposal for regulation of OTC derivatives that is based clearing. tation will only bring these commodities market as a bouquet financial instruments most importantly whether the new of new products and new big-ticket further under reforms should cover just OTC deriva. which is expected through central counterparties (CCPs). adopting of the general similarities between the regulatory Dodd-Frank principles in advance of EU regulations. they cannot Therefore. conservative in regulatory policy than the US under it now appears that the EU will ultimately fashion a Dodd-Frank. Dodd-Frank ration of Dodd-Frank style reporting obligations. Until a consensus their commodity exchanges to foreign investment. and capital adequacy. The amendment will allow introduction of an Frank. the Financial Instruments and Exchange Regulatory overhaul in the EU Act is the primary legislation responsible for regulating Following the G-20 Pittsburgh mandate. transactions by global financial entities on foreign exchanges would appear to be subject to Dodd-Frank Derivatives regulation in Asia regulation if they have a direct and significant effect There are no proposals for pan-regional regulation of on US commerce. trans. on September derivatives.com/in/en A PwC & MCX Joint Endeavour 47 012-053_CIYB_2011_Exper's Views. control. CCPs would be subject to strict will strengthen regulation greatly by extending the regulation. Fortunately. However. calamities. this exemption only applies if the Dodd. but unlike Dodd. regulation in the EU and the US may lead to increased European regulators have already used much of Dodd- costs and loopholes that could be exploited in order Frank as a model to regulate their own markets. Thus. similar to extremely cautious about the process of opening up those granted under Dodd-Frank.AGRI COMMODITIES Moreover. which will are following a similar timeline to the EU regarding the be required to publish aggregate positions and share implementation of these new regulatory requirements. country-by-country basis. www. China certainly does not appear to regime very similar to Dodd-Frank.com / www. including requirements of transparency. EMIR requires that derivatives regulators appear largely receptive to Dodd-Frank and trades be reported to trade repositories. In Japan. A key aspect of MiFID is its incorpo. non-US traders whose derivative regimes of the US and Europe. Central Bank and many large industrial Alarmed at the effect of speculation on companies are concerned that the new regulations price volatility and the contributions of derivatives to could damage bank liquidity. and continue to push the 2008 financial crisis. crucial to the next-level growth of the issues still need to be resolved. banks and foreign The EU Commission is currently properly. it is extremely unlikely activities significantly impact US commerce are also that these regions will adopt regulations that are subject to Dodd-Frank regulations. can be reached on the proposed rules. the clearing requirements. As the holders to be passed in the next session of Parliament . thereby to avoid the intent of regulations. be a jurisdiction to which derivatives traders will flock The Markets in Financial Instruments Directive to escape the early implementation of Dodd-Frank. Japanese similar to Dodd-Frank.indd 47 1/26/2012 1:40:50 AM . an amendment to the Forward Contracts all standardised derivatives transactions be cleared Regulation Act (FCRA). DATABANK . it is fair to expect that China will be more be negotiated in the European Parliament. the European Commission issued the contain provisions similar to those contained in Dodd- European Market Infrastructure Regulation (EMIR). The Act’s extraterritorial impact will require Many market observers and participants are foreign traders with US customers to alter their behaviour concerned that a lack of coordination between so that it is consistent with the statute’s mandates. Chinese regulators remain for exemptions from clearing requirements. (MiFID) constitutes another EU attempt at financial regulation. EMIR also requires that In India. As is true of Dodd-Frank. The European needed liquidity into the system. 2010. of substantial risk.pwc. The recent amendments to this act also 15. array of new products and facilitate entry Frank is the entity’s trades fall below a certain right mechanism of large institutional participants such threshold.NON-AGRI COMMODITIES DATABANK . worldwide. The MiFID is a non-binding directive that Conclusion dictates the regulation of all financial instruments The misuse of derivatives was one of the primary causes within the EU. 1952. Further.is a regulatory framework that will prevent similar future parency. However. EMIR exempts authority and autonomy of the commodities market non-financial users hedging commercial risk from regulator Forward Markets Commission (FMC). A number of important of the world and implemen.of the 2008 economic collapse. and exchange-like trading.

6 Banks. 2010. r_110415b.net/capcon/cftc/100510/Side-by-Side%20 TIMES. Financial Lobbies Warn on Inconsistent Derivatives Rules. right mechanism to regulate derivatives properly. instruments further under control. available at http:// TIVES. L. July 1.capitolconnection. DERIVA.D. Department D and the Department of Homeland Security. Professor Greenberger may be reached at mgreenberger@law.. 111-203.llsdc. J. October 5. §722(d)(i)(1). html?_i_location=http%3A%2F%2Fwww. available at http://in. December 8. Moreover. 7 European Commission. 2011. 11 4 Id.org/attachments/files/239/CRS-R41398.pdf. April 15. Professor Greenberger allow derivatives trading at present. available OTC Derivatives in Japan. June 27. 2011. Making Derivatives Markets in Europe Safer and 13 Financial Services Agency. available www.com/article/2011/07/06/ Dodd-Frank Wall Street Reform and Consumer Protection Act. Moreover.reuters. FINANCIAL TIMES.html&_i_ George Mathew. knowing that universal testimony te before numerous committees in both the United States S Senate and House of Representatives. Pub. Many smaller was asked to testify before House and Senate oversight committees on the effective countries that may continue unregulated markets have implementation of Dodd-Frank and present at three different roundtables sponsored by CFTC and SEC staffs. html#axzz1SlUtNRGW. 1-7. REUTERS. Derivatives Plan. likely provide a regulatory of o the UN General Assembly on Reforms of the International regime that is much tougher than Dodd-Frank. 2011.com/intl/ of%20Dodd-Frank%20and%20Foreign%20Legislation-Final%2010%20 cms/s/9504c274-a656-11e0-ae9c-00144feabdc0. Pub. 5 derivatives-trading-idUSL6E7I61NE20110706. He also served on the Steering Committee of major trading venues give every indication that they the President’s Working Group on Financial Markets and as a member of the International will follow Dodd-Frank. available at http://www.. CFTC. and Joshua Prada for their invaluable contri- butions to this article. key countries in Asia. 12 Rachel Armstrong. Public Consultation: Review of the Markets PROGRESS REPORT ON IMPLEMENTATION. He has also authored several chapters and scholarly articles risk from trading malpractices. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Because regulators in Asia are moving indepen- About the Experts dently and without a pan-regional structure.) References 1 MARK JICKLING & KATHLEEN ANN RUANE. 2011.do?reference=IP/10/112 gov/ucm/groups/public/@aboutcftc/documents/file/gmac_100510_ 5&format=HTML&aged=0&language=EN&guiLanguage=en.edu Villa. Brussels. the US should not wait for Asia to implement regulatory PROFESSOR MICHAEL GREENBERGER who P teaches te “Futures. J.pdf. J.financialstabilityboard. 2011. REUTERS. 2011. 2 Financial Stability Board. No. when they open their markets to to the United Nations Commission of Experts of the President generic derivative trading. July 4. Directorate General Internal available at http://www. 5%2010.com%2Fcms%2Fs% 2F0%2F9504c274-a656-11e0-ae9c-00144feabdc0. European Groups Fear OTC STREET REFORM AND CONSUMER PROTECTION ACT: TITLE 7.pdf.pdf.D. Amendment Bill in Next Session. New Regulation of More Transparent. at http://www..eu/rapid/pressReleasesAction.Authorised=false. Many Markets M at the Commodity Futures Trading Commission (CFTC) in 1997 and served through 1999.com/intl/cms/s/0/08d136fe-ae38-11e0-8752-00144feabdc0.cftc. available at http:// 8 Nicki Tait. 1376 (2010). 124 Stat. available at http://www. Asia’s Derivative Reforms Set to Heap Pain on Dodd-Frank Wall Street Reform and Consumer Protection Act. 124 Stat. This work has included preparing less fanfare to be adopting it. Mr George Waddington. L. it is umaryland. He became Director-Trading and to less heavily regulated markets ring hollow. in Financial Instruments Directive (MiFID). available at http://www. Monetary M and Financial System. July 14.ft.com/news/optimistic-about- magazine/interview/2080962/deconstructing-emir.risk. will. Brooke Masters & Nikki Tait. eu/internal_market/consultations/docs/2010/mifid/consultation_ paper_en. He filed over 20 comment letters on proposals by regulators little liquidity or otherwise expose traders to extensive implementing Dodd-Frank. and as a member of the International In Energy Forum’s Independent Expert Group In addition.europa. OTC DERIVATIVES MARKET REFORMS: 10 European Commission. available at http://ec. Dodd-Frank is the about Dodd-Frank. July 6.indd 48 1/26/2012 1:40:50 AM . available at http://www. available at http://www.reuters.edu already being followed in numerous parts of the world and implementation will only bring these financial MICHAEL VESELY joined the Center for Health and M Homeland H Security as a staff attorney in February 2007. FINANCIAL www. including of o Maryland School of Law. RISK MAGAZINE. J. September 15. Trudy Henson. has served as Technical Advisor India and China. ‘Optimistic About Parliament Passing FCRA 14 referer=#axzz1REbE4Cqc and Matt Cameron.D. arguments that increased Dodd- providing p recommendations to the IEF’s 12th Ministerial Frank regulation will cause investors to move funds March M 2010 Meeting. parliament-passing-fcra-amendment-bill-in-next-session/809040/2. 48 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. at http://europa. Anthony Vesely V may be reached at mvesely@law. 2011. fsag. 111-203.org/publications/ Market and Services. article/2011/04/18/idINIndia-56405320110418. while Since S then he has written extensively on derivatives and complaining about Dodd-Frank large banks seem with other o financial instruments. IP/10/1125. 1376 (2010). Other important venues do not Organization of Securities Commissions’ Hedge Fund Task Force. 2010). April 18.net/risk.. Government of Japan.ft. 2010.umaryland. also a worked on economic security issues for both the State (The authors would like to thank Jung Lee. Derivatives Reform: Comparison of Title VII of the Dodd- Frank Act to International Legislation.com/ No.D. Options and Derivatives” at the University reform.pdf. Deconstructing EMIR. §722(d)(i)(1). Mr Vesely has adoption is inevitable.indianexpress.ft. THE DODD-FRANK WALL 9 Jeremy Grant. 2 (Congressional Research Service August 30. Brussels Delays Decision on OTC Rules. October 2010. 3 Id. Indian Express. 2010.

pwc.mcxindia. DATABANK .com / www.com/in/en A PwC & MCX Joint Endeavour 49 012-053_CIYB_2011_Exper's Views.AGRI COMMODITIES www.NON-AGRI COMMODITIES DATABANK .indd 49 1/26/2012 1:40:52 AM .

at a macro-level. it is important to realise that the commodity derivatives market. markets have received their share of Such price risks are inherent in market forces. financial institu- on many. and the market itself. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Market as a "bail-out" institution: Commodity exchanges in liberalised trade regime By Nilanjan Ghosh. plays a much larger role against the socio-institutional backdrop of a liberalised economic regime. This is true for all sorts of markets. the last link in the value 50 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views.indd 50 1/26/2012 1:41:41 AM . Therefore. P robably no other economic institution has traded in international and domestic markets have exerted a wide-ranging influence on human been subject to violent price fluctuations. rather than the government exchequer. exposing society like markets. For some markets While affecting various stakeholders in the interna- have proved bountiful. and result in lop-sided As is commonly known. while for others they turned tional commodity ecosystem including governments. censure. growth. it is necessary to nurture institutions like commodity exchanges so as to enable them to play such a transformational role effectively. besides facilitating price discovery and price risk management. their vigorous volatility has pauperised tions. endeavour. In a broader perspective. can act as a more sustainable bail-out institution against its own vagaries. Despite immense commodity-dependent. apart from appreciation. movements of commodity prices enfeeble economic including international markets for commodities. traders. and so on. Consumers. MCX It is time one appreciated that use of commodity derivatives is particularly necessary in an increasingly liberalised environment. Head ± Research & Strategy. skew purchasing power. developing countries to contribution in every aspect of human extreme uncertainties and economic instabilities. processors. out to be ruthless! While they have showered wealth producers. agricultural commodities development. the precarious countless people.

“Price Discovery in Commodity Markets: Floated Myths. the share is almost 75 percent5 [Pal and responses. producers. or through market-based 1 World Bank. stocks have not proven effective. on international prices. June 23–24. www. Buffer production decisions sharp peaks.C. Gilbert. as prices endure longer than price producers' delayed and can be seen by the large accumu. lations under the US and EU farm signals. being involved with government funds Apart from international trade dynamics. Internationally.NON-AGRI COMMODITIES DATABANK . supply and natural trade in India. Another set of policies deals with government absorbed by the market system. inapt responses to price spikes. as in the cases of coffee. This distinction is important for commodity prices can be attributed to a number of informing policy responses: short-term shocks should demand. processors.any supply shocks in major exporting countries to be tions1. pp. and change in technology. is that only a household budget planning – keep aside the problems limited number of exporting countries dominate inter- of price rise due to supply-side problems. 42 (5). Raipuria. there are inherent risks national commodity agreements have shocks.” PREM Notes. as stated by Ghosh8 (2008). 2008. Asia Publishing House. Even for a This has prompted governments.pwc. to widely produced crop such as rice. 2004. DATABANK . Economics of Hedging. 1999.. in production management. 33. worldwide.S.” Economic and Political Weekly.mcxindia. commodity price schemes. p. a distinguishing feature of international trade. 38 (51). private or the public sector. Ghosh. and tobacco. 2003. 5330. periods of low and market delivery. are endogenous to the market system. 419. 1975. delayed and inappropriate responses agreements. aggregate supply and. there supply and natural shocks. The Theory of Futures Trading. cit. Mumbai. From the supply be dealt with by saving or borrowing. Popular Prakashan.indd 51 1/26/2012 1:41:52 AM . Hence.38. lower been costly.com / www. These attempts. Bombay. and inelastic commodity markets. Governments and top five exporters is more than 76 percent and for central banks have come up with multi-dimensional all cereals. 8 K. op. the share of the manage commodity price risks. 4 P. does not allow foreign exchange needs and changing fiscal condi. “Commodity Risk Management for Developing Countries.” Commodity Vision. are hit severely by the uncertainty that affects particularly of agricultural commodities. rubber. 5082–85. 2007. 1 (3). include buffer stocks.” i. traders. the exchequer2 [World Bank (1999)]. And government intervention has and should be attributed to oversupply. prices of and governmental intercessions. whether by the side.” Paper prepared for the Third Meeting of the International Task Force (ITF) Meeting held in Geneva. This lop-sided trading pattern. 5 Ibid. “Commodity Exchanges Are Not Stock Exchanges. with unintended consequences. tions. pp. according to Cashin and Pattillo9 (2000). 6 Ibid.and supply-side factors. and diversify On the other hand. 9 N. “Using Markets to deal with Commodity Price Volatility. proponents of market forces as the information and analyses mechanisms were have traditionally advocated commodity derivatives not perfect7 [Raipuria (2003)]. Inter. Flouted Realities. hence. caused by time lags between production decisions and so far. changes in commodity prices3 [see Venkataraman There are two types of commodity price fluctua- (1965). which treasuries have attempted to tackle fluctuating applies to most primary commodities.AGRI COMMODITIES chain. For many crops placing unnecessary pressure on the government — for example. Buffer funds have gone volatility is caused cycles are characterised by “flat bankrupt. “Commodity Price Volatility and Special Safeguard Mechanisms.e. “Price Stability and Futures: Need for a Macro-development Framework. central banks and Wadhwa (2007)]. Madhoo Pavaskar. Washington D. have mostly been many commodities reveal a high degree of volatility classified as “Keynesian” in nature. tea. As suggested is little evidence of success of such High price by Gilbert6 (1999). These risks lapsed. On the one hand. commodity market delivery. growers did not know when to stop. cocoa. as evidenced in Australia by time lags between bottoms punctuated by occasional and Papua New Guinea. pp. The problem of infor- markets to have helped traders and manufacturers mation asymmetry is rampant in Indian agricultural in coping with price risks arising from unknown future marketing. supply shocks intervention in commodity markets in order to protect in these countries can have a very high impact on consumers. and sugar. buffer funds. Wadhwa. shift. 1965.” Economic and Political Weekly. or government intervention in by producers to price signals. pp.” Economic and Political Weekly. coffee. The schemes. 39 (48). 3 L. 417–27. Madhoo Pavaskar. thereby demand. Venkataraman. national trade4 [Pal and Wadhwa (2007)]. and inelastic Even in the context of domestic programmes in the late 1980s. 2 World Bank 1999. 7 C. World Bank. Pal and D. etc. tin. Pavaskar (1975 and 2004)].com/in/en A PwC & MCX Joint Endeavour 51 012-053_CIYB_2011_Exper's Views.. These are short-term (under four years for half the shock’s The market dynamics effects to dissipate) and long-term (where there are The traditional high volatility of international permanent effects). 1999.

excessive speculation. cit. thereby leading to overall efficient price formation. 2007. even if it does not explain everything. “Terms of trade shocks in Africa: Are they short-lived or long-lived?” IMF Working Paper. sends out wrong take a long position of the same size in the futures price signals at wrong times. Pattillo.cit. Wadhwa. one takes an equal and opposite position in a derivatives or has to face the vagaries of the market mechanism. It harnesses inefficiency. First. the price out" institution level established in the open market can represent No doubt. Washington. whose use is spreading uncontrollably. if the hedger has taken a cannot do any good to the agriculture of emerging short position in the physical market. and C. Page. Today. 2001. etc. Pal and Wadhwa11 (2007) keep on arguing in favour of The two major functions of a derivatives/futures special safeguard mechanisms (SSMs) in agriculture market are price discovery and price risk management under WTO. one has to appreciate that the market itself. and greater dependence on imports. (hedging). and A. op. and programmes that deal with uncertainty using This can happen in two ways. Second. op. Hewitt. 13 World Bank 1999. The financialisation of agricultural markets. which include the role of private liberalised agriculture is the prime. of the various types of risks that an accurate depiction of the market conditions of a loom large over the agricultural sector. IMF. government policies. the above arguments against subsidisa. Pal and D. 11 S. 12 P. in the context market instruments12 [World Bank (1999)]. efficient and viable for risk management and price Long-term shocks require permanent changes in the discovery is the use of derivatives/futures if there economy10 [Page and Hewitt (2001)]. players. the prices discovered through such a market’s price discovery mechanism reflect infor- Commodity derivatives market: A "bail. facilitate integration futures and cash prices. 417–27. sustainable and can at best provide temporary relief. mation about the market. such as insurance. The use of such The big challenge of price volatility and the an instrument is particularly — and even more — capacity to cope with it poses major policy concerns. futures market vis-à-vis his/her spot (physical) market Yet. pp. cians and policymakers emphasise the distinction Ideally. is wide stakeholders’ participation. market players can simulta- rather than the government exchequer. Thus. a participant With agriculture becoming liberalised over time. In the process. 2000. bution of prices — domestically or internationally. necessary in an increasingly liberalised environment. World commodity prices: Still a problem for developing countries? Overseas Development Institute. price risk of specific commodity. 52 Commodity Insights Yearbook 2011 012-053_CIYB_2011_Exper's Views. That is. Impor. one has to understand that an insulated system exposure (position). is a contributory factor in price volatility and food risk management mechanisms. and reduces growth and market to hedge against the price risk.. academi. While Bank and UNCTAD (1996)]. DC. Cashin. Such uncertainties and risks posed by fluctuating Derivatives (futures) markets can complement prices can threaten the performance of the commodity and even substitute traditional policy instruments sector through reduction in investments and export generally used to cope with price volatility13 [World earnings. The notion of hedging or price risk management tions clearly indicate that SSM regimes are in no way is well explained in textbooks of finance and economics. PROLOGUE EDITORIALS EXPERTS' VIEWS EXPERTS' VIEWS INDIAN ECONOMY Agri-commodities are now among the underlyings of financial derivatives. commodity derivatives/futures exchanges between programmes that attempt to alter the distri. To hedge or manage his/her price risk. of non-conformity of the two markets because of tantly. can act as neously take equal and opposite positions (long or a more sustainable “bail-out” institution against its short) in the futures and the physical markets and own vagaries. he/she should economies. A market mechanism that is more bring the markets to conformity..indd 52 1/26/2012 1:41:55 AM . during 10 P. competitiveness of the agricultural sector.

W.AGRI COMMODITIES delivery. unaffected by the forces A change in socio-economic processes of international trade and finance. (NBOT) in Indore follows that of the CBOT. A natural are anonymous public auctions with prices displayed resource re economist and econometrician by training and a PhD from IIM Calcutta. SVP and Head of Research D which makes the futures and cash prices converge. He H co-edited a MacMillan publication.com thereby reducing the information asymmetries. Before MCX. His publications include books.Ghosh@mcxindia. economic. 1996.NON-AGRI COMMODITIES DATABANK . derivatives market development to testify this fact. have established commodity deriv- The evolution of the Chicago Board of Trade (CBOT) ative markets to deal with basis risk and international from 1848 in the USA is a well-documented case in price volatility. All exchanges eventually popular writings. Several Sweden. The importance of CBOT thus emerges from documented for Dalian Commodity Exchange (DCE) the changes in institutional practices in the domain in China. time and flagship publication.pwc. 5 (2). Global Environmental Outlook 4. Yet. for research and teaching in December 2008. and commodity markets. (2011): “An Institutional Reading of the Very Early History of the Chicago Board of Trade: What it means for What we need to Study about Indian Futures Market”. Dr Ghosh may be reached at Nilanjan. www. which can minimize the adverse selection and moral hazard interests of eastern cities like New York with the problems in transactions. cit. (1991): Nature’s Metropolis: Chicago and the Great West. B.ghosh@gmail. One also cannot ignore the and colonisation of the hinterland of the Great West. A combined dynamics of enabling discovery. Dr Ghosh has also served as an expert reviewer for several first-rate journals. The evolution of CBOT also needs the WTO norms. The devel. Evidences Some developing countries including Argentina. Information and commu. op. and it has had on the socio-politico-economic stratum of Tokyo Commodity Exchange or TOCOM (which provides human existence. players can demand to receive or deliver the About the Expert physical product through the exchange. Saha. critical role of this market in the broader spectrum of the increasing volumes of grain production. As an institution matures (derivatives) markets. and socio-institutional changes. has been extensively working in As futures contracts are traded on exchanges that the th commodity derivative markets space. and helping in local price other developments. (2 His prime research interests and contribu- Prices of many commodities so discovered on tions ti are in the domains of economics of water resource the Chicago Board of Trade (CBOT) are taken as the confl c icts. For example. apart from its dual roles of price discovery prices do not move in line with prices in international and price risk management. 14 World Bank and UNCTAD.com/in/en A PwC & MCX Joint Endeavour 53 012-053_CIYB_2011_Exper's Views. Chicago emerged as a preferred city playing the window of opportunities that invariably accompany a critical role in linking up the broader commercial these challenges. ecological economics. India. Governance. Malaysia. (2010-12). hinterland of the west. This phenomenon increases the basis risk for a much larger role in the socio-economic-institutional any commodity — a situation when local agricultural backdrop. emphasised their roles in price discovery at the 25-odd research papers in peer-reviewed journals. a benchmark for price discovery in Middle East Crude Oil) (UNCTAD 2009)14. Concluding remarks Generally.indd 53 1/26/2012 1:41:56 AM . greater alignment and exposures to international trade. again. New York: W. no doubt. thereby ensuring a constant nication technology has definitely played a crucial flow of commodities over a large geographical role in this context. which is hitting the stands shortly. One may reduce basis risk with and develops. and international or the local level. He visited School of Social Sciences. As a developing nation. Environmental reference prices for trading worldwide.com and endeavour to carry out effective price dissemination. physical. does prove a case for a developing nation factors included new investment in infrastructure like India to encourage further development of the agri- (railroads and telegraph). The success of agri-commodity futures this regard (Cronon 1991. the Philippines. Brazil. DATABANK . an insulated economy. Saha 2011) . A Lead Author of the UNEP’s commodity exchanges around the world have. it brings along changes that are social. Norton and Co. it is important to realise in prices in the local economy from those prevailing that the commodity derivatives/futures market plays globally. Växjö University. review articles. these markets perform the important Secretary S of the Indian Society for Ecological Economics function of price discovery. the threat of DR NILANJAN GHOSH. Dr Ghosh was associated soybean oil futures contract at National Board of Trade with TERI University. working papers.com / www.mcxindia. New Delhi. Hungary. 15 UNCTAD (2009): Development Impacts of Commodity Exchanges in Emerging Markets (New York and Geneva: UNCTAD). the burgeoning settlement commodity futures market. and philosophical. galore in international experiences of commodity China. to be seen in the context of the dynamics of inter-city are enormous. nilanjan. & Strategy at MCX. Bursa Malaysia (which is often claimed to of agricultural marketing as well as from the impacts have discovered the prices of Malaysian palm oil). reveals divergence In a broader perspective. and South Africa. 56-64.W. in various other countries in dealing with international opment of CBOT needs to be located within several agricultural price volatility. the impending challenges. Russia. Such attempts have been well expanse. one cannot close one’s eyes to rivalry. 16 Cronon. Commodity Vision. Dr Ghosh is also the General for all to see. as passage through the commercial hubs to find the we move towards trade liberalisation in compliance with distant markets.