KUCHING: The financialisation of the commodity market is generally beneficial as it provides a means for the transfer of price risks from hedgers to speculators.
However, the benefit may not be attainable if financial investors employ a herd mentality investment strategy by simply following the market consensus rather than bringing diversity to the market.
The Economic and Social Survey of Asia and the Pacific report by the regional development arm of the United Nations (UN) Economic and Social Commission for Asia and the Pacific (ESCAP) stated that such financialisation could potentially drive prices away from fundamentals and increase their volatility.
It cautioned that Malaysia being among the world’s top palm oil producing countries needed to take heed that although economic fundamentals were the main long-term drivers of commodity prices, the increased participation of financial players in the market had raised concerns that speculation might have contributed to spikes in prices.
“The participation of financial investors in commodity markets accelerated when the subprime crisis soured investors’ interest in complex asset-backed securities, prompting a kind of flight to simplicity,” stated the report.
The share of commodity assets under management in global gross domestic product (GDP) increased fourfold between 2008 and 2010 alone and monetary easing in the advanced economies had also contributed as it led to a massive expansion in liquidity.
Despite losing their shares in the nation’s GDP, Malaysian commodities, especially palm oil, natural gas and crude oil still retained high rankings in the nation’s GDP and with investors not actually holding commodities but seeking arbitrage opportunities in commodities futures and options market, speculators tended to reduce the speed of adjustment towards market equilibrium.
The report noted that this highlighted a new role for speculators in the commodity market.
“There is nothing inherently wrong with speculation in the commodity market, nor is it a new phenomenon. Speculation in the futures market, whether in financial assets or commodities, assists in the process of price discovery and provides buyers with access to supplies according to their requirements spread over time at predetermined prices.
“However, at the same time, a massive and sudden surge in non-commercial investments in the commodity futures market could inflate commodity prices and distort the price discovery process,” stated the report.
Investors should pay attention to the fundamentals and have strong strategies that will be beneficial in the long term.