World Commodity Prices and Markets Dr Wyn Morgan Sixth form Conference 27th June 2006

Question: what links Chinese economic policy with a crime committed in Sinfin in June? Answer: the price of copper. Why? China is growing rapidly and demanding commodities such as copper, thus prices have risen sharply Criminals see prices rising and try to supply some from a community centre!

Figure 1: Copper Prices $/tonne (July 05-June 06) Source: BBC

Outline 1. Commodities defined 2. The main features of commodity markets 3. Price behaviour 4. Policies for commodity markets 5. Conclusions/questions

1. Commodities Defined A commodity is something that hurts when you drop it on your big toe, or smells bad if you leave it out in the sun too long (Barrons 27 th June 1983) Primary commodities are natural and have not been processed into other products What types of internationally traded primary commodities are there?

Food/Beverages Coffee, cocoa, sugar, wheat, maize, rice, bananas, beef Minerals and Metals Tin, copper, zinc, nickel, iron ore, aluminium Agricultural Raw Materials Rubber, cotton, tobacco, oilseeds, soybeans, oils (palm, groundnut) Fuels Oil, gas and coal

2. What are the Main Features of Commodity Markets? Major share of world trade 23% including fuels 14% excluding fuels Many countries export & import (see Table 1) Most DMEs net importers (except Australia and Canada)

Demand – generally stable Necessities (e.g. food) Low degree of substitution Low income elasticity for food Inputs into manufacturing production: Copper in construction or palladium for mobile phones Some substitution (e.g. rubber)

Supply – can be volatile Not just developing countries (see Table 2) Time period for supply means short run is a long time and elasticity low e.g.: Minerals need new mines Coffee bushes need 7 years to mature Effect of shocks Permanent - new processes Temporary - weather

Graph 1: Commodity Market with Supply Shock Price Quantity S1S1 D S2S2 P2P2 P1P1 Q1Q1 Q2Q2 S3S3 P3P3 Q3Q3

Graph 2: Commodity Market with a Demand Shift Price Quantity S P1P1 Q1Q1 D1D1 D2D2 P2P2 Q2Q2

3. Price Behaviour Commodity prices exhibit two main features: 1. A high degree of volatility (see Table 3) arising mostly from supply volatility 2. Downward trend relative to manufactured goods

Do these features represent a problem? Volatility Input price volatility Labour and capital costs known, other inputs not – what happens? Who pays for this? Inflation effects? Selling price volatility Producer income unknown Investment difficulties

Downward Trend LDC producers rely on export revenues Need manufactured goods for growth Try to produce more to increase revenues: Y = PQ Increase Q to offset fall in P but this causes P to fall! Problem of dependence on a few commodities for export earnings (see Table 4)

4. Policies for Commodity Markets What do countries want? DMEs want good supplies but with stable and fair (low??) prices LDCs want increased export earnings but want them to be stable (high prices??) How can these be reconciled? By managing the market

International Commodity Agreements Buyers and sellers control supply to keep prices in a stable range Supply controlled by production limits, export quotas, buffer stocks etc

Graph 3: Price Bands in a Commodity Market Price Quantity S D PuPu PePe QeQe PLPL

International Commodity Agreements Buyers and sellers control supply to keep prices in a stable range Supply controlled by production limits, export quotas, buffer stocks etc Existed for a number of commodities: sugar, coffee, cocoa, rubber, tin All collapsed due to disagreements between the two sides

One-sided interventions Supply control by producers (cartels) e.g. OPEC Controls supply by quotas and can increase prices (see 1973/4 on Figure 1) Protection of domestic producers e.g. Common Agricultural Policy Use tariffs and artificial prices to raise incomes for EU farmers Impact on world markets significant

Other Policy Issues in Commodity Markets Development and growth concerns Diversification of production in LDCs Inflation in DMEs Environmental concerns Technological change and its effects Market power and prices Risk management

5. Conclusions/Questions Commodities are important for both LDCs and DMEs Commodity markets have stable demand but potentially volatile supply Prices can be volatile in short run and downward trending in the long run Intervention can affect prices but what are the welfare implications of such policies?