Speculation and Commodity Prices

Abstract

This paper attempts to identify the role of financial speculation in commodity price movements, while exploring other possible influences such as the role of spare capacity and the role of rapidly developing countries, through intensive commodity import surges. Both fundamentals and speculation appear to jointly determine crude oil prices. Speculative activity does play a supporting role in price determination but it is not the only driver. Fundamentals such as net imports, the result of consumption and production dynamics, are important in price determination. Attempts at investigating the role of spare capacity, however, found that capacity bottle neck is not an important cause of recent price movements. A production level is still primarily the most important driver on prices of wheat and is heavily reliant on weather. Speculation does not have a significant effect of prices, but position limits may disrupt hedging activity that helps stabilize wheat prices. Even though speculation have some influence on crude oil prices, setting an across the board position limit may harm the price stability in wheat markets. Market wide position limits should consider the impacts on the futures market as a whole rather than piecemeal.