Commodities and Value Chains
Commodities and Food Security
Factors of food market instability:
|Factor||Direct effect||Long term effect||Mitigation of adverse impact|
|Unexpected production/consumption shock||Unexpected price change||Additional costs to adjust production systems to reduce the impact of future shocks||Use of derivative price risk management instruments
Macro level insurance
National and regional buffer stocks
|Systemic trend due to change in technology or consumption patterns||Pressure on market prices. Little immediate impact||Gradual change in global pattern of production and consumption of commodities||Investment in productive capacity
Buffer stocks ineffective
|“Assetization”: trading of commodities as investment assets||Transmission and amplification of shocks;
Transmission of financial liquidity and its volatility to commodity markets
|Greater uncertainty and deterrent to investment in productive capacity||Equal access to financial markets, capital mobility
Regulations to level the playing field for physical commodity producers and consumers
Buffer stocks ineffective
|Trade restrictions and protectionism||Restricted physical availability and amplified impact of physical supply/demand shocks||Erosion of global productive capacity||Trade rules and irreversible commitments
Investments in food derivatives such as futures and options have increased greatly. The increase in buying food derivatives has come from large investors who are attributed to largely invest for speculation. There is no consensus about the relationship between food commodity derivatives markets and the volatility of prices. According to a College of London study, there is compelling evidence that increased speculation “is causing adverse impacts on global food prices and there is therefore a need for the commodities future market to be regulated more effectively.” There are also competing views [e.g. Gilbert] which expect financial markets to reduce the volatility of commodity markets. Greater transparency concerning the positions of financial investors in commodity markets had been identified as a major point in improving the understanding of financial impact on commodities.
1. Improve markets to reduce volatility by:
- increased transparency commodity transactions through central clearing,
- disclosure of aggregate positions by different investor classes (based on the investment strategy), and
- restricting banks to their core functions.
The discussion is still wide open on measures that need to be undertaken, or can be taken at the international level. The radical proposal in this regard is to “leave commodity market to commodities”, remove or prohibit financial investors from commodity markets and regulate commodities separately from finance because of food commodities social significance. Specific regulatory measures that can be considered are:
- futures market regulations, multi-tier tax on transactions for different investor classes;
- position limits based relevant to market practice;
- public reporting of market activity;
- different treatment of commercial and speculative business.
Other measures that can enhance coping capacity of commodity dependent developing countries to price volatility inter alia include:
- food security stocks;
- hybrid or virtual buffer stocks combining small physical stocks and virtual reserves based on hedging instruments;
- countercyclical support policies, compensatory finance;
- policies expressly aiming to exploit commodity boom to move up the value-chain i.e. value addition;and
- regional markets and linkages to diversify markets.