Commodity Investing is Different (Updated)

Robert Samuelson weighs in on the side of the fundamentals of supply and demand being the primary culprits behind the rising prices of oil and other commodities:

Granted, raw materials prices have exploded across the board. From 2002 to 2007, oil rose 177 percent, corn 70 percent, copper 360 percent and aluminum 95 percent. But that’s just the point. Did “speculators” really cause all those increases? If so, why did some prices go up more than others? And what about steel? It rose 117 percent — and has increased further in 2008 — even though it isn’t traded on commodities futures markets.

A better explanation is basic supply and demand. Despite the U.S. slowdown, the world economy has boomed. Since 2002, annual growth has averaged 4.6 percent, the highest sustained rate since the 1960s, says economist Michael Mussa of the Peterson Institute. By their nature, raw materials (food, energy, minerals) sustain the broader economy. They’re not just frills. When unexpectedly high demand strains existing production, prices rise sharply as buyers scramble for scarce supplies. That’s what happened.

He continues with an explanation of the futures markets:

Commodity price increases vary because markets vary. Rice isn’t zinc. No surprise. But “speculators” played little role in these price run-ups. Who are these offensive souls? Well, they often don’t fit the stereotype of sleazy high rollers: Many manage pension funds or university and foundation endowments.

Their trading might drive up prices if they were investing in stocks or real estate. But commodity investing is different. Investors generally don’t buy the physical goods, whether oil or corn. Instead, they trade “futures contracts,” which are bets on what prices will be in, say, six months. For every trader betting on higher prices, another is betting on lower prices. These trades are matched. In the stock market, all investors (buyers and sellers) can profit in a rising market, and all can lose in a falling market. In futures markets, one trader’s gain is another’s loss.

That’s basically what I’ve been saying all along. Still, speculators have from time to time attempted to corner the market on one thing or another. The Hunt Brothers and silver, for example. IIRC these attempts haven’t been very successful historically and spectacular rises have been followed by meteoric falls.


If you’d like to see the details with graphs, charts and what-not on the fundamentals mentioned above and why we shouldn’t expect much improvement for the foreseeable future, see This excellent post at The Oil Drum: Europe. Most specifically it’s extremely obvious that we cannot reduce the price of oil by cutting back on consumption. Any foreseeable U. S. and European conservation will be overwhelmed by increases in Chinese consumption.

3 comments… add one
  • That’s consistent with my reasoning on the fundamentals being primarily responsible for the runup in oil prices. The additional complication is that most countries in the world—both those whose consumption is declining as in Europe and those whose consumption is rising as in China and the Middle East—are relatively less sensitive to the price of oil than we are.

    The Chinese and people in the Middle East are less sensitive because oil consumption is subsidized and the Europeans are less sensitive because oil is heavily taxed and the market price of oil pays relatively less role in prices at the pump.

  • Yep–but it’s important to note that fundamentals still indicate a much lower price when you adjust out those future supply expectations. More like $60-80/bbl at current production rates. Any solid indication that we were actually making some REAL effort to exploit our own extremely considerable reserves would do. Such as Congress lifting the moratoriums that keep offshore drilling impossible, and/or permitting work on coal-to-oil plants or dopping the blockade on shale oil production.

    We are hostage as much to our own government’s lack of seriousness in addressing our foreign oil dependence as anything else. There is NO lack of oil and oil equivalents available to us in this country, just a lack of the political will required to develop those resources.

    Not that we shouldn’t continue to gain efficiencies through technology and to develop better and more cost-effective alt-energy sources–we certainly should, and deploy them as they become economically viable–but the hard reality is that our domestic conventional reserves of oil and shale oil and coal can be developed much more quickly than any of the alt-energy alternatives, and for most of the alternatives the infrastructure to deploy them simply isn’t there, and can’t be put in place nearly as quickly as a boost in conventional source processing can.

    IOW, we have to act decisively for the long term to get short term prices down.

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