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COMMON FUND FOR COMMODITIES
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Commodities and Food Security

Soaring food prices have again brought international attention to the world agricultural production, its risks and resulting limits to economic growth and development, as well as social, economic and political consequences of food markets instability. The international community is concerned about the rising global impact of expected global events and news. Any news relating to likely production shortfalls or disruption in supplies leads to large price swings.

What is causing these price spikes? In recent year volatile prices have been attributed to a variety of random events, e.g. severe weather events in Russian Federation, dry weather in Brazil, flooding in Australia. Furthermore, a number of systemic factors have been identified as possible causes behind upward pressure on grain prices, such as increasing demand on account changing dietary patterns with rising incomes in developing and emerging economies; rising prices of oil which have direct bearing on production and transportation costs; production of some types of bio-fuels such as corn-based which become more viable with increasing oil prices. Furthermore, many experts believe that increasing attention to commodities as an asset class, and the resulting increased derivative trading in soft commodities can amplify the impact of unexpected events, increasing price volatility beyond that given by the fundamentals. An additional cause, often mentioned by the media, is export restrictions such as export bans or imposition of export quotas.

Factors of food market instability:

 

FactorDirect effectLong term effectMitigation of adverse impact
Unexpected production/consumption shockUnexpected price changeAdditional costs to adjust production systems to reduce the impact of future shocks

Use of derivative price risk management instruments

Macro level insurance

National and regional buffer stocks

Food aid

Systemic trend due to change in technology or consumption patternsPressure on market prices. Little immediate impactGradual change in global pattern of production and consumption of commodities

Investment in productive capacity

Buffer stocks ineffective

"Assetization": trading of commodities as investment assets

Transmission and amplification of shocks;

Transmission of financial liquidity and its volatility to commodity markets

Greater uncertainty and deterrent to investment in productive capacity

Equal access to financial markets, capital mobility

Regulations to level the playing field for physical commodity producers and consumers

Buffer stocks ineffective

Trade restrictions and protectionismRestricted physical availability and amplified impact of physical supply/demand shocksErosion of global productive capacity

Trade rules and irreversible commitments

Buffer stocks

While it is accepted that more investment is required in agriculture to enhance production and productivity and there is a need to reverse the neglect of agriculture over last many decades, it is also necessary to take action to address the impact of climate change by introducing large scale adaptation and mitigation measures to overcome its adverse impact. Models of climate change seem to indicate that the world can expect increasing frequency of floods, droughts and other weather related events affecting agriculture and thus food security.

Investments in food derivatives such as futures and options have increased greatly. The increase in buying food derivatives has come from large investors who are attributed to largely invest for speculation. There is no consensus about the relationship between food commodity derivatives markets and the volatility of prices. According to a College of London study, there is compelling evidence that increased speculation "is causing adverse impacts on global food prices and there is therefore a need for the commodities future market to be regulated more effectively." There are also competing views [e.g. Gilbert] which expect financial markets to reduce the volatility of commodity markets. Greater transparency concerning the positions of financial investors in commodity markets had been identified as a major point in improving the understanding of financial impact on commodities.

Realizing the linkages between the physical and financial markets, the Common Fund for Commodities” held a conference on “Promoting Beneficial Global Financial & Commodity Market Synergies” at Brussels in December 2010 and the major recommendations of the experts were:

1. Improve markets to reduce volatility by:

  • increased transparency commodity transactions through central clearing,
  • disclosure of aggregate positions by different investor classes (based on the investment strategy), and
  • restricting banks to their core functions.

2. Regulations and International measures to mitigate the impact of market volatility

The discussion is still wide open on measures that need to be undertaken, or can be taken at the international level. The radical proposal in this regard is to “leave commodity market to commodities”, remove or prohibit financial investors from commodity markets and regulate commodities separately from finance because of food commodities social significance. Specific regulatory measures that can be considered are:

  • futures market regulations, multi-tier tax on transactions for different investor classes;
  • position limits based relevant to market practice;
  • public reporting of market activity;
  • different treatment of commercial and speculative business.

Commodity producers will be affected by regulations through market linkage. Successful regulation would make the markets easier to “read” to more participants, makes participation could be more dispersed, information asymmetries could be reduced. Prices may be less volatile, but could also be lower, as risk premiums would fall.

Other measures that can enhance coping capacity of commodity dependent developing countries to price volatility inter alia include:

  • food security stocks;
  • hybrid or virtual buffer stocks combining small physical stocks and virtual reserves based on hedging instruments;
  • countercyclical support policies, compensatory finance;
  • policies expressly aiming to exploit commodity boom to move up the value-chain i.e. value addition;and
  • regional markets and linkages to diversify markets.