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Commodity derivatives

In any financial market, it is helpful to have a small proportion of speculators. Their activity – buying and selling to benefit from price changes – helps other investors to trade quickly, especially when other counterparties cannot be found. This is true for commodity derivatives as well.

But there is another side to the story. Click the picture above to see a short video explaining the problem.

Part of the story is that in less than 10 years, the proportion of speculative activity in this market has jumped from 30% to more than 70%. This has changed the dynamics of the market, with consequences for producers, wholesale buyers and consumers alike.

Finance Watch Commodity derivatives

Source: Michael Masters testimony before the Commodities Futures Trading Commission, 25 March 2010

The growth in speculative trading is largely the result of new investment products that channel savings into commodity “investments” (Exchange Traded Funds or ETFs). In fact, these products are channelling savers’ money into derivatives.

Finance Watch Commodity derivatives

Source: Bloomberg, MTN-I, ETP issuer data, Barclays

 

With commodities closely linked to food and fuel prices, vulnerable households suffer the most and the consequences are serious. The chart below overlays the rise in food prices with social unrest (deathtolls in brackets).

Finance Watch Commodity derivatives

Source: Lagi, Bertrand and Bar-Yam (2011)

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