The Commodity Markets Conundrum — Are You Ready For Rising Prices and Variable Demand?

In the office and at home, I tend to follow the prices of commodity prices closely. Of course it helps that my wife tracks the metals markets for many of her waking hours, and we're also surrounded by smart people in our profession who look closely at metals plus a range of other commodity markets. Yet it seems at the moment that there's a great debate brewing over where prices might go in the coming months. I've thought for some time that continued speculation by non-buyers (i.e., investors, traders, etc.) combined with the reduced production and longer lead-times inherent in a sustained downturn or relatively flat market coming out of a recession will lead to upward price pressure, just as it did in the last boom when a number of commodities increased by three or four times. Now it appears others are getting on the commodities bandwagon too, owing to speculation, among other reasons (which makes sense considering that the fall is historically a terrible time to be in the US equity markets).

Consider this recent article in the Journal that suggests, "markets for commodities such as oil, copper, grains and gold have had strong trading volume as investors look for ways to further diversify their portfolios and gain exposure to additional asset classes tied to the health of the global economy." Of course the continued speculation is even more interesting considering the theme of the article, suggesting that banks are facing more scrutiny than ever on the commodities trading and derivative front. Moreover, if there's potentially less liquidity in customized commodity products as a result of new trading and accounting rules, the price to hedge may increase further, even if there is limited impact on underlying commodity prices tied to contracts.

The WSJ captures a simple example in the article to explain the underlying intricacies and concerns over why some trading houses have gotten in trouble. Consider how, in a common example, "an airline may turn to a bank to sell jet-fuel futures contracts over the counter on its behalf, transferring the risk from fluctuating prices over to the financial institution. In many cases, the bank would then take additional positions in futures markets to reduce its exposure from the trade with the airline." However, "if a client is looking to use unique or rarely traded contracts, a bank may take on risk exposure for some time." In other words, the bank is not just brokering the risk, but assuming it on its books.

I continue to believe that procurement professionals need to learn more about how commodity markets work and ways they can incorporate supply and price risk management techniques by both actual and virtual (e.g, ETF) hedging strategies. Yet I'm not seeing an uptake in the questions I'm getting on the subject nor the interest I think the topic deserves outside of the CPG/food marketplace. Hopefully, however, as commodity prices continue to make the headlines and as procurement stays front and center in the battle to maintain continuity of supply while mitigating price risk in risky market environment, I do think this will change.

Jason Busch

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