Commodity Dynamics: A Sparse Multi-class Approach

The correct understanding of commodity price dynamics can bring relevant improvements in terms of policy formulation both for developing and developed countries. Agricultural, metal and energy commodity prices might depend on each other: although we expect few important effects among the total number of possible ones, some price effects among different commodities might still be substantial. Moreover, the increasing integration of the world economy suggests that these effects should be comparable for different markets. This paper introduces a sparse estimator of the Multi-class Vector AutoRegressive model to detect common price effects between a large number of commodities, for different markets or investment portfolios. In a first application, we consider agricultural, metal and energy commodities for three different markets. We show a large prevalence of effects involving metal commodities in the Chinese and Indian markets, and the existence of asymmetric price effects. In a second application, we analyze commodity prices for five different investment portfolios, and highlight the existence of important effects from energy to agricultural commodities. The relevance of biofuels is hereby confirmed. Overall, we find stronger similarities in commodity price effects among portfolios than among markets

HEDGING WITH FUTURES AND OPTIONS UNDER A TRUNCATED CASH PRICE DISTRIBUTION

Many agricultural producers face cash price distributions that are effectively truncated at a lower limit through participation in farm programs designed to support farm prices and incomes. For example, the 1996 Federal Agricultural Improvement Act (FAIR) makes many producers eligible to obtain marketing loans which truncate their cash price realization at the loan rate, while allowing market prices to freely equilibrate supply and demand. This paper studies the effects of truncated cash price distributions on the optimal use of futures and options. The results show that truncation in the cash price distribution facing an individual producer provides incentives to trade options as well as futures. We derive optimal futures and options trading rules under options as well as futures. We derive optimal futures and options trading rules under a range of different truncation scenarios. Empirical results highlights the impacts of basis risk and yield risk on the optimal futures and options portfolio.farm programs, futures, hedging, options, truncation, Marketing,

Implications of Integrated Commodity Programs and Crop Insurance

Moving from price-triggered to area revenue–triggered programs was perhaps the most common theme among 2007 farm bill proposals. Area revenue–triggered commodity programs may make farm-level revenue insurance products seem redundant, raising questions about why the federal government should continue both programs. Area revenue–triggered programs would remove much of the systemic risk faced by producers. As a result, private sector insurers may be able to insure the residual risk without federal involvement. This paper examines the effects of moving to area revenue–triggered commodity programs with a focus on public policy issues that would likely arise.commodity programs, revenue insurance, systemic risk, Agribusiness, Crop Production/Industries, Productivity Analysis, D81, G22, Q18,

Commodity investments: opportunities for Indian institutional investors

An attempt has been made to establish the fact that by investing in commodities or it alternative channels, institutional investors like banks can not only compensate for the lower risk-free returns in their major chunk of investments in Government securities, but also will be able to diversify some amount of their portfolio risk which is expected to rise by taking exposure in commodity market. The results exhibited in all the tables and figures clearly depict that investment in alternative channels like commodity indices or commodity futures contracts in India will not only allow the institutional investors to leverage their portfolio return, but also will ensure that diversification benefits is achieved. Therefore, even if investment in direct commodities are restricted for Indian banks, but still there is a significant opportunity for them to invest in the available alternative channels like commodity indices or commodity futures contracts.Investment Portfolio, Commodity, Commodity Futures, Institutional Investors

The Need for Transparency in Commodity and Commodity Derivatives Markets. ECMI Research Report No. 3, 15 December 2008

This paper argues that transparency-boosting measures specifically tailored to commodity and commodity derivatives markets are much needed. In particular, encouraging the creation of a clearing infrastructure for OTC commodity and commodity derivatives markets would be desirable. Moreover, EU regulators should consider setting up a new, more effective market abuse regime aimed at preventing manipulation in both the physical and financial commodities markets. Finally, in cooperation with the G20, EU authorities should consider the creation of an International Commodity Agency to increase transparency and restore confidence in international physical markets for commodities. The paper is structured as follows: Section 2 briefly discusses the fundamentals of commodity spot and futures markets. Section 3 presents both physical commodity markets and commodity derivative markets in their usual breakdown categories: agriculture, metals and energy. Section 4 discusses the regulations in the EU and the US concerning commodity derivatives. Section 5 advances certain policy proposals and the last section draws the conclusions

Soft commodity funds, food price volatility, speculation and public Perception. Why soft commodities are a special asset class.

This paper reviews evidence on food price volatility, soft commodity speculation and the public perception of these practices, at least from a Belgian perspective. Soft commodity speculation expanded greatly during the 2007-2008 food crisis and since then has become an asset class of its own in which many banks and investment institutions engage in. This is fueled by food price volatility, especially for the soft primary commodities wich teh food industry uses as ingredients: cereals, oilseeds, vegetable oil, sugar, coffee, cocao, etc ... Of course, speculation is not new and extends to all primary commodities, to stocks and bonds, currencies, and in fact all asset classes. What is special about soft commodity(comprising all agricultural products and raw materials for the food, fiber and bio-fuel industry)speculation is that it impacts our dialy food, and that there are nearly one billion people in the world that are chronically food insecure, i.e. don't have enough to eat every day for a normal and healthy life. The recent food crisis added more than 100 million people, according to FAO, to that group. The 50 poorest countries in the world ) basically all agriculturally based economies-are nearly all net importers of food, particularly cereals, and thus depend on the world market for their food supply. Many poor families spend over half their income on food. And this is why food price speculation raises many ethical questions and why soft commodities - the basis of food - are a special asset class.

A Second Look at the 2007-08 Food Price Crisis: Considering the Impact of Endogenous Dynamics on Food Prices

This paper offers an alternative to the conventional explanation of the 2007-08 food price crisis in terms of escalating demand or dwindling supply. Instead, its focus is on the legal-institutional structure of commodity futures markets, which has witnessed a drastic alteration in the role of speculators. These have transformed from “market makers” (that keep commodity futures markets liquid by arbitraging on price fluctuations) to "market breakers". Index speculation, in particular, has had the effect of muddling information about market "fundamentals" because of the need – brought about by commodity index swaps – for swap dealers to hedge the fluctuations of an index of commodity prices by opening and periodically rolling over long-only positions. This periodical rollover to comply with contractual obligations, rather than in response to anticipated fluctuations in the availability of a commodity in the future, can induce a "contango bias" in the commodity futures market that, in turn, might have given the wrong signals to market operators, leading to a condition of induced (rather than pre-existing) scarcity and to an increase in spot prices in the 2007-08 crisis

TRADE AND MACROECONOMIC POLICY: WHAT DOES IT MEAN FOR FARMERS AND LENDERS?

International Relations/Trade,

Is export diversification the best way to achieve export growth and stability? A look at three African countries

Malawi, Tanzania, and Zimbabwe depend heavily on export earnings from a narrow base of agricultural commodities (coffee, cotton, sugar, tea, and tobacco). This dependence increased between 1961 - 1973 and 1974 - 1987, when international prices for those commodities were declining and unstable. Policymakers concerned with the instability and downward trend in export earnings for the three countries, tend to equate these trends with the countries'narrow export commodity base. They often propose export diversification as an expedient remedy. But the authors found that horizontal diversification would have produced lower export earnings and more instability. Policymakers introducing horizontal diversification must first consider price forecasts, comparative advantage, the economy's changing structure, and the costs of adjustment. Reactions to historical price movements can produce unexpected, undesirable results. A shift during this period from favorable to unfavorable price trends, and shifts in the covariances of deviations from price trends, complicate the design of export diversification policies, especially policies aimed at stabilizing export earnings. Generally, the most effective way to achieve growth and stability in export earnings is to increase and stabilize agricultural production and the volume of exports. The authors analysis shows that different export diversification policies can help fulfill different policy goals.Economic Theory&Research,Airports and Air Services,Achieving Shared Growth,Water Resources Assessment,Crops&Crop Management Systems

Commodity risk management and development

In 1995, 57 countries depended on three commodities for more than half their exports, reports UNCTAD. And commodities, fuels, grains, and oilseeds are important imports for several countries. The notorious volatility of commodity prices is a major source of instability and uncertainty in commodity-dependent countries, affecting governments, producers (farmers), traders, processors, and financial institutions. Further, commodity price instability has a negative impact on economic growth, income distribution, and poverty alleviation. Early attempts to deal with commodity price volatility relied on buffer stocks, buffer funds, government intervention in commodity markets, and international commodity agreements to stabilize prices. These were largely unsuccessful--sometimes spectacularly so. Buffer funds went bankrupt, commodity agreements were suspended, buffer stocks proved ineffective, and government intervention was both costlyand ineffective. As the poor performance of such stabilization schemes became more evident, academics and policymakers began distinguishing between programs that tried to alter price distribution (domestically or internationally) and programs that used market-based approaches for dealing with market uncertainty. This change in approach coincided with a significant rise in the use of market-based commodity risk management instruments--aided by the liberalization of markets, the lowering of trade and capital control barriers, and the globalization of commodity markets. by the mid-1990s, several governments, state companies, and private sector participants began using commodity derivatives markets to hedge their commodity price risks. Participation in those markets is growing, but important barriers to access remain including counterparty risk, problems small groups (such as farmers) have aggregating risks, basis risks (no correlation of local and international prices), no local reference prices, low liquidity, no derivatives markets for certain products, and low levels of know-how. International institutions, local governments, and the private sector could facilitate developing countries access to derivatives markets and the use of risk management tools to solve public sector problems.Economic Theory&Research,Payment Systems&Infrastructure,Environmental Economics&Policies,Markets and Market Access,Labor Policies,Health Economics&Finance,Insurance&Risk Mitigation,Environmental Economics&Policies,Access to Markets,Markets and Market Access