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Commodity Monthly

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Where are the psychical stocks?

Wed, Jul 9 2008, 08:08 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

The question of whether food and energy prices have been pushed higher by fundamentals or by speculation has fuelled an intense debate lately. Currently, no less than nine bills are on their way through the US Congress aimed at cracking down on speculation. Three proposals from independent Connecticut Senator Joe Liebermann, who sees 'excessive market speculation', have attracted the most attention. The most drastic would prohibit pension funds from investing in energy and food commodities. However, he also proposes stricter rules on the total share of commodity markets held by financial investors, and new rules on speculative OTC derivatives trading and hedging by investment banks in the futures market.

We certainly agree that speculative and pension fund money can increase commodity market volatility from day to day, week to week and even month to month. But such money does not, in our view, decide the longer-term trends in commodity prices - that is down to fundamentals. One should also remember that speculative money secures liquidity for global commodity markets. Abundant liquidity allows commercial buyers and sellers to hedge future commitments on a large scale and at a very low cost. Nevertheless, are speculators to blame for the long rally in, for example, oil prices, or the latest spike in grain prices? Are speculators and pension funds inflating commodities? Are we seeing a commodity bubble?

Increasing inventories due to falling demand or rising supply alongside increasing prices would suggest a bubble. Any freshman in economics knows that when prices are too high for demand to equal supply then stocks grow due to excess supply. This is exactly what happened in the US housing market a few years ago, and a bubble ensued. The problem in energy and agricultural is, however, that there is simply no build-up in stocks – demand continues to power ahead despite higher prices. Hence, we do not share the view that commodity prices are speculatively driven. Of course, this does not rule out lower prices going forward. In fact, we expect to see oil prices soften later this year, as the fundamental picture has, in our view, weakened significantly in the past two months. We believe the market has failed to correctly anticipate the consequences of such high prices on demand. Hence, when spare capacity and probably also non-OPEC supply rise later this year, prices will come under pressure. But this has nothing to do with speculation. It is just the market realising that 'demand destruction' is stronger than forecast. However, should oil prices soften we would not at all be surprised to hear Senator Joe Lieberman claim victory over the speculators - but that is another story.

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Published on  Wed, Jul 9 2008, 08:13 GMT