Pricing and Commodities

Commodity prices are very persistent. During booms, we seem to forget that they have always (yes, always) been followed by busts. And, during a slump, we forget that a boom is surely going to come along — we just have to wait long enough. What determines such booms and busts?

Where are prices today relative to longrun trends? And, the big question: where are prices likely to go from here? Before seeking more complicated stories, three aspects of commodity theory should not be overlooked. First, commodities can be stored, implying a trader can buy today and pay the costs (of financing that purchase and storage) and sell in the future.… The relationship between the total availability of a commodity and the spot price is not straightforward.

As availabilitydeclines before reaching the extreme of a stock-out, prices will rise faster and faster.… The second aspect is that prices can be very non-linear.… High prices stimulate investment. And, we still don’t have atotally satisfactory model for commodity prices that has rational stockholding and incorporates forward-looking investment that may take time, may be lumpy.…

Whatever the micro-foundations, a third aspect is that commodities do seem susceptible to price and investment booms, followed by crashes, then supply slowly readjusts. Indeed, the very high uncertainty in any commodity price projection underlines the need for commodity exporting countries(and some importers) to find ways to manage these risks.

From “Commodity Prices: Over a Hundred Years of Booms and Busts”


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