My post on “The financials of 2008 – What will we talk about” has proven itself so far (to my great surprise). True, I didn’t think the credit crisis would prove to be so deep but my thoughts on inflation, commodity prices and the Chinese market were pretty accurate. In this post I’ll be sharing my observations on commodity prices. Naturally, this is my personal opinion and should not be used to make investment decisions.
Commodity prices have continued their unprecedented rise. Corn, wheat, rice, oil and many other commodity prices have all skyrocketed. The rise in basic food products’ prices have caused riots to erupt in developing countries such as Egypt, Cameroon and Burkina Faso. Other countries such as Vietnam, India and Pakistan have banned grain export as farmers and traders hold on to stock and await more price increases.
The whole word is anxiously watching food prices rise like they never did before.
Is there a just and sensible reason to the rise in food prices?
Yes and no. Confused? So am I. As developing countries developed so did the demand for food and other commodities. Economists list many reasons for the rise in commodity prices. Among these are the following:
Increased consumption and standard of living especially in south-east Asia causing a rise in demand for both foods and other commodities such as oil and metals.
The price increase of raw materials caused manufacturing and growing costs to rise as well.
Global warming which has caused a shortage in wheat crops.
Ethanol and bio-fuels competing for corn crops.
It seems, however, that commodity prices are also a target for highly speculative investments causing greater fluctuations and a sort of overshooting in prices.
Will Prices Remain High?
Prices will remain high for sometime. As I’ve written before it takes time to fulfill growing demand for commodities as more fields need to be planted and agricultural and genetic developments need to be introduced to farmers in developing countries. This will happen eventually and faster than we think. We all know what good motivator money is and with food prices so high the motivation is bigger than ever.
It also seems the current slump in crop yields is just that: a slump. Should a couple of years of better crops ensue prices will react pretty sharply. If you believe global warming is responsible and things will only get worse than you better stock up. I personally believe a process such as global warming takes more time to impact. I hope I’m not wrong.
Furthermore, if indeed commodity prices are the subject of heavy speculative investments hedge funds and their likes will eventually turn to other assets, after maximizing their potential profit in commodities. Such a change would lead to a drop in prices.
Hopefully oil prices will remain just high enough to keep alternative fuels economically worthwhile thus reducing pollution and also reducing the world’s dependency on oil producing countries, which aside from Canada and a few selected others have been corrupted by this natural resource and are not model countries to say the least.
One more aspect to consider is the monetary side. Another interest rate cut is expected in the US but Bernanke’s running out of interest rate to cut. The ECB (European Central Bank) has chosen to combat inflation and has left interest rates untouched through out this crisis. In England interest rates were cut by a mere 0.25% if I’m not mistaken and that was due to a housing problem developing there as well.
Interest rates will not remain at such a low level for a long time. A rise in interest rates will affect commodity prices and lower them as higher interest rates both reduce the demand for storable commodities and increase their supply. Higher interest rates provide a higher incentive to “extract” today rather than tomorrow, decrease the economic incentive to carry inventories and most importantly might draw speculative money out of commodities and back to treasury bills.
Image by bernt
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