Commodity Prices Are Always Volatile - Essay Example

Question Commodity Prices are expected to be Volatile than the Prices of Manufactured Goods: Introduction: Commodity prices are always volatile than the prices of manufactured goods. That means there will always be fluctuations in the prices of commodities. In this paper an attempt is made to find out the reasons for the volatility of commodity prices as compared to prices of manufactured goods. The word commodity refers to anything which is traded in the market which does not include manufactured goods, pepper, wheat, oil, and livestock. Manufactured goods refer to goods which are produced for the final consumption or for using them as raw-material for some other products. Examples are tyre, table, etc. The word volatile means flexible. In other words it means something which is subject to change. Commodity prices are more volatile than the prices of manufactured goods because of the following reasons: 1. Interest rate: Commodity price changes inversely with the interest rates. That is, the higher the interest rate, lower the commodity price and the lower the interest rate higher the commodity price. 2. Future Trading: The futures contract refers to an agreement between two parties for the purchase or sale of goods or bill of exchange which is being fixed at the time of agreement, but the actual delivery of goods take place at a future date. “In futures trading, there is usually a contract, which is essentially an agreement between two parties to buy or sell an underlying asset at a certain time in the future at a certain price. A futures contract usually has a standardized date and month of delivery, quantity and price.” (Futures Trading). Futures trading: Future contracts result in the prices of commodities becoming more flexible. In order to safeguard the interest of some parties in future trading some company may opt for increasing the prices of commodities. Future trading mostly happens in commodities. For manufactured goods, future contracts are very less. So the prices of commodities are more volatile than the prices of manufactured goods. 3. Demand and Supply of commodities: Demand and supply of the commodities are other reasons for the price volatility of the commodities. That is, the commodity market is more price elastic. A slight change in demand or supply of the commodity may result in a very high change in the price of the commodities. But in the case of manufactured goods the price elasticity is very less. That is, change in demand or supply results in a very low change in price of the goods. So the prices of manufactured goods are less volatile. 4. Large number of producers: There will be large number of producers for the commodities. This results in frequent fluctuations in the prices of commodities. When one producer reduces or increases the price of any commodity, others are also forced to do so. This makes the price of commodities more volatile. In case of manufactured goods, there will be lesser number of producers. In other words there is less number of competitors in this market. So there will not be frequent changes in the prices of manufactured goods. 5. Availability of substitutes: In this context substitutes refer to products or commodities which can be used in place of one another and provide the consumer with same level of satisfaction. Examples: Tea and coffee, sunflower and coconut oil. As most of the commodities have large number of substitutes, the price of these commodities would be more volatile. But in case of manufactures goods lesser number of substitutes are available and the price of these goods would be less volatile. Uses: Most of the commodities are having large number of deployment. Commodities like cement, steel, aluminum etc. have many uses. So the price of these commodities would be subject to more fluctuations. But in case of manufactured goods there is limited number of uses; therefore its price would be less flexible. The graph given below shows the cycle of real price of industrial commodities during the period of 1862-1999 (Cycles in Real Price of Industrial Commodities, 1862-1999). Commodity prices are more volatile than the prices of manufactured goods due to the influence of many factors. “Commodity prices on world markets are now tumbling, and fast—a result of the withdrawal of vast sums of speculative money compounded by glum expectations of lower demand from the troubled global economy. The effect is a perfect storm of market forces that has precipitated a slump in commodity prices.” (From Feast to Famine). Question 2: Explain how expansion of bio fuels could push up prices of soybeans, meat, and poultry: The following chart depicts comparative increase in demand for food and non-food. (Helbling, Blackman and Cheng). It is seen that the world has witnessed mounting oil prices in recent years along with the fact that many richer countries, particularly members of EU and USA have been giving out generous aids to smaller countries. This has led to the use of bio-fuels being used as an addition for transportation fuels, particularly in advanced economies of the world. Especially so, USA, which has left Brazil far behind in production of ethanol, it is seen that this accounts singularly for nearly “80% of bio-fuel use.” It is also seen that the food stocks are being diverted from production of bio-fuels instead of food, which is creating a price asymmetry—in other words, the prices of petroleum products are deciding retail prices of bio-fuels, and increase of bio-fuels, in turn, “is strongly affecting feedstock prices (ethanol, in particular, is produced from corn and sugar).” (Helbling, Blackman and Cheng). It is seen that in the decades to come, bio-fuels would constitute a major part of transportations and this being the case; it is quite possible that the upward surge in food prices due to greater usage of bio-fuels would be present for quite some time, in the future. Again, it is also seen that demand for bio-fuels has stimulated not only the prices of corn but also those of other food stuff, because corn is used as a basic input, in the manufacturing process, or as a near substitute. It is seen that in the context of America, the demand for bio-fuels has triggered off price increases in other product lines also, due to application of economic laws. “To a lesser extent, demand for biodiesel has also affected prices of edible oils, because soybean oil and other vegetable oils such as palm oil and rapeseed oil are used as biodiesel inputs.” (Helbling, Blackman and Cheng). (Helbling, Blackman and Cheng).Thus it is seen that it is basically the operation of demand supply and greater dependability on ethanol based fuel (bio-fuels) that has been instrumental in major hikes in prices of soya, bean, and meat and poultry products. In order to control food prices, it is essential that a balanced, sustained and economic use of bio-fuels be propagated and the elements of protectionists be actively discouraged, including allowances to US and EU. Conclusion: Economists are of the opinion that Brazilian sugar cane-based ethanol works out cheaper than American corn-based ethanol. Therefore, by resorting to large scale production and distribution of ethanol, it is possible to place limits on bio-fuels which, in turn, could help control rise in prices of food commodities like soybeans, meat and poultry products. Again, the dependence on ethanol may be reduced by seeking and promoting alternative and cheaper versions of bio-fuels, which could help stabilise its pricing structure; this could, in turn, have a positive effect on food products also through lowered freight and transportation charges, roll back of duties and fuel charges and a more efficient and effective method of bio-fuel usages. The need for rolling back fuel prices may have a cascading effect on bio-fuels also, since lowering of bio-fuel costs could also result in reduction of costs of food items. . Works Cited Brown, Oil. From Feast to Famine. IISD: International Institute for Sustainable Development. 16 Jan. 2009. . Cycles in Real Price of Industrial Commodities, 1862-1999. Amazon.com. 2005. 16 Jan. 2009. . Futures Trading. Futures Trading Info. 2004. 16 Jan. 2009. . Helbling, Thomas., Blackman, Valerie Mercer., and Cheng, Kevin. Riding a Wave. International Monetary Fund. 2008. 45.1. 16 Jan. 2009. . Helbling, Thomas., Blackman, Valerie Mercer., and Cheng, Kevin. Riding a Wave: Falling Inventories. International Monetary Fund. 2008. 45.1. 16 Jan. 2009. . Helbling, Thomas., Blackman, Valerie Mercer., and Cheng, Kevin. Riding a Wave: Rising Demand. International Monetary Fund. 2008. 45.1. 16 Jan. 2009. . Read More