Friday, September 02, 2011

Speculative hunger

Much like I said in my recent postings about Total Factor Productivity, the absence of profitability in certain sectors of the economy leads to investors chasing the last refuges of security and profitability. Everyone has been talking about gold (although, its rise in price in an effect of inflationary printing of money).

Now, the Spiegel has a report on speculation in food that is well worth the read.
The result of the team's efforts bears the innocuous title: "Price Formation in Financialized Commodity Markets: The Role of Information." But the contents are explosive. The UNCTAD experts conclude that the commodities market isn't functioning properly, or at least not the way a market is supposed to function in economic models, where prices are shaped by supply and demand. But the activities of financial participants, according to the study, "drive commodity prices away from levels justified by market fundamentals.
Most investors involved in the commodities business today have little understanding of the actual products. "Market participants also make trading decisions based on factors that are totally unrelated to the respective commodity, such as portfolio considerations, or they may be following a trend," the UNCTAD report concludes, describing the dangerous herd mentality of investors. According to the report, such behavior has nothing to do with objective pricing."
In other words, purveyors of effective demand are seizing upon the carrier signal and in the process distorting it, a bit like someone confusing the words for the poem - if I have more words, my poem is better."(From the UNCTAD report).

Essentially, the Efficient Markets Hypothesis is exploded - the idea that "all publicly available information is immediately reflected in prices. In its strong form, the EMH contends that even private information – available only to individual market participants – is reflected in the price through the effects of the transactions of the persons in possession of the information."

Market actors move as a heard, and react to one another (and the price signals) despite any other objective knowledge. The report calls for more transparency and regulation - but really, total transparency requires opening the books, which in turn requires common ownership, rather than the game of market smoke and mirrors for private advantage.
"The financialization of commodity trading has made the functioning of commodity exchanges controversial. Their traditional functions have been to facilitate price discovery and allow the transfer of price risk from producers and consumers to other agents that are prepared to assume the price risk. These functions are impaired to the extent that trading by financial investors increases price volatility and drives prices away from levels that would be determined by physical commodity supply and demand relationships. As a result, commodity price developments no longer merely reflect changes in fundamentals; they also become subject to influences from financial markets. Consequently, market participants with a commercial interest in physical commodities (i.e. producers, merchants and consumers) face greater uncertainty about the reliability of signals emanating from commodity exchanges. Thus, managing the risk of market positions and making storage, investment and trading decisions become more complex. This may discourage long-term hedging by commercial users. Moreover, with greater price volatility, hedging becomes more expensive, and perhaps unaffordable for developing-country users, as well as riskier."

Labels: , , , , ,


Post a Comment

<< Home