Amos Newcombe’s Weblog

2008 April 20 Sunday

Commodities and speculation

Filed under: outlook — anewc2 @ 21:44

Commodities are expensive. Some see this as a temporary thing — that as the recession kicks in, prices will come back down due to lack of demand. Others see it as a response to longer-term response to supply and demand fundamentals. Paul Krugman is in this latter group.

We’ve had a huge runup in commodity prices — fuels, food, metals.
But why? Broadly, the debate is between those who see it as a
speculative phenomenon, driven by some combination of low interest
rates and irrational exuberance, and those who see it as a collision of
rapidly growing demand with constrained supply.

My problem with the speculative stories is that they all depend on
something that holds production — or at least potential production —
off the market. The key point is that the spot price
equalizes the demand and supply of a commodity; speculation can drive
up the futures price, but the spot price will only follow if the higher
futures prices somehow reduces the quantity available for final
consumers. The usual channel for this is an increase in inventories, as
investors hoard the stuff in expectation of a higher price down the
road. If this doesn’t happen — if the spot price doesn’t follow the
futures price — then futures will presumably come down, as it turns out
that buying futures produces losses.

View Original Article

He backs it up with charts to show that metal and oil inventories are in line with recent history.

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