I'm a few days late in tipping my hat to Bob Dylan’s 80th birthday, but he has a line to suit most occasions. This week it's Ballad of a Thin Man’s “something is happening here, but you don’t know what it is”. That’s what came to mind when I read about China’s recent clampdown on alleged speculation, fake news, and hoarding in the commodities markets. Just as Western governments pointed the finger at speculators in 2008 as oil prices spiked to nearly $150 a barrel, the Chinese authorities are looking to apportion responsibility for costs that threaten to dent the country’s growth as factory gate prices increase at the fastest rate in years. It’s understandable, but it misses the point. There really is something important going on here, but it’s not what Beijing thinks.
Speculators are easy to blame. But commodity markets are not the place to make bets that are not backed by a strong economic case. The cost of holding physical commodities is high, so speculation in natural resources takes place in the futures markets, and these are efficient. For every song, there’s a short. Positions will only move prices to the extent that they reflect relevant information about supply and demand. Any that don’t will soon be met by a countervailing bet. Bubbles are short and self-defeating.
Far from increasing volatility, speculators actually reduce it by immediately factoring in new information before the official data catches up. Speculation allows small adjustments in price to pre-empt bigger shifts down the track.
Goldman Sachs, in an interesting update this week on its commodities supercycle thesis, highlighted the anomaly of onion futures, in which trading has been banned since the Fifties following suspected manipulation of the market. Volatility in onion prices is consequently much higher than in commodities like corn, where there is efficient price discovery.
China may be fighting the commodity price battle on the wrong front. During the last big commodity cycle in the decade after 2000, it was the dominant influence on commodity prices. Then Chinese demand was the swing influence as the country’s absorption into the global economy, infrastructure build-out, and urbanization of its workforce fuelled massive demand for energy and raw