Volatility of Agricultural Commodity Prices - Essay Example

? The Global Economy THE GLOBAL ECONOMY Discuss the factors influencing the volatility of agricultural commodity prices and themechanisms available for governments and businesses to manage these price movements. Prices of agricultural commodities, it has been argued, are volatile due to short run supply and low elasticity. Regardless of volatility’s definition, empirical evidence exists that shows that much time series volatility is not constant over time (Cooke & Robles, 2011: p12). Changes in volatility are can be seen in simple plots of absolute price changes from time to time. They demonstrate average volatility shifts of many prices of agricultural commodities and finds further support in implied volatility evidence. This happens against a backdrop of shifts towards global markets and market liberalization, as well as dramatic alterations within the energy sector with regard to bio-fuel production. One factor that affects the volatility of these agricultural commodity prices is trends (Cooke & Robles, 2011: 56). Long run decreases or increases in series volatility may occur. These can be accounted for by the inclusion of time trends in variables explaining volatility. Another factor is stock levels. As stock levels of various commodities drop, there is an expectation that volatility in prices of these commodities will also increase. Low stocks will lead to dependence, on current production, to meet consumption demands in the short term also increasing. Further yield shocks could portend an increasingly dramatic effect on the commodity prices. The yields for particular crops will also drive a commodity’s price up or down. In relation to expectations, a large yield may cause prices to drop while a particularly low yield may result in an increase, in the price (FAO, 2011: p123). If the prices respond in a symmetrical manner to the yields, then no impact will be expected on the series volatility. If, however, a bigger yield impacts more on the prices, then volatilities will be positively related to yields while, conversely if lower yields have more impact on the prices than higher yields, then the volatilities will have a negative correlation to the yields. Another factor has to do with the transmission across prices. Positive transmission of price volatilities is expected across agricultural commodities. Global markets do experience international shocks that could influence the world demand for agricultural commodities with these markets also adjusting to policy movements, which may impact simultaneously on a number of commodities (FAO, 2011: p124). In addition, Volatility in a particular market may have a direct impact on another’s volatility where stocks are speculatively held. Exchange rate volatility is another factor that affects volatility of agricultural commodity prices (Hill, 2011: p33). Prices received by producers on deflation into the domestic producer currency may impact significantly on commodity prices at which the producers are prepared to sell. This is also extended to stockholders. Volatile rates of exchange significantly increase the risk inherent in returns. Therefore, it is expected that a positive volatility of exchange rate transmission could result in agricultural commodity price volatility. Oil price volatility is another factor with perhaps the biggest agricultural production shifts in the past decade, and one that is expected to continue, being the move towards the use of bio-fuels (Hill, 2012: p56). Recent empirical studies have suggested the transmission of prices between sugar prices and oil. A likely link also exists between the costs of input and that of output. Freight costs, mechanized agriculture, and fertilizer prices all depend on the price of oil, which are transmitted to agricultural commodity prices. In light of the recent unprecedented volatility of oil prices, this volatility shows a potential to spill over into agricultural commodity volatility. For example, the sudden interruption of fuel availability during the Iraq war in 2002 given the geo-political events that occurred in the Middle East, as well as the curtailment of production in fossil fuel that accompanied it, caused an increase in the price of fuel around the world. This led to a breakdown in all levels of food production from the farmers to the processors all the way to retailers and consumers. High oil prices, therefore, are a big contributor to volatility in agricultural commodity prices. The present agricultural systems are highly dependent on oil and, given the affordability of oil are decreasing the price of agricultural commodities is increasing. Within the current agricultural and energy systems, there is no solution in sight for the worsening agricultural commodity price volatility facing the world. Export concentration is yet another factor. A decrease in the number of countries exporting agricultural commodities could expose the global market to variability in exportable supplies, domestic events like policy changes, and weather shocks (Lines, 2011: p78). Lower export concentration may cause higher potential volatility while higher concentration may lead to lower potential volatility. Finally, interest rate volatility may cause agricultural commodity price volatility. They are a vital macroeconomic factor that could portend a direct effect on commodity prices because they represent a cost to stock holding. However, they also act as a vital indicator of economic conditions. Therefore, interest rate volatility may also act as an indicator of economic uncertainty and subsequent commodity demand (Lines, 2011: p79). Numerous proposals have been put forward to control the volatility of agricultural commodity prices. Establishment of virtual reserves can be used to combat the actions of speculators who drive up commodity prices, and thus, moderating spot prices in the market (Atkin, 2009: p44). Several studies have suggested that changes in future prices of particular commodities could lead to the spot price changes. Spot prices are usually discovered in futures markets. It is evident that alterations in futures prices lead to spot price changes more often than not. Therefore, from a perspective of policy, the implementation of global virtual reserves carries viability in addressing excessive spikes or dips in commodity prices via futures market signals and, where necessary, maintain economic conditions, as well as subsequent commodity demand. Options also exist, in the improvement of coordination and information, to improve market confidence, as well as relieve temporary supply disruptions (Munier, 2012: p90). An international food agency could be created after the International Energy Agency model, which reports stock levels and comes up with protocols aimed at international collaboration in the improvement of the global response to shortfalls and aid in offsetting market panic. Another proposal has to do with the facilitation of trade so as to mitigate grain trading risks when there are low supplies and also avoid the disruption of the grain market (Munier, 2012: p92). A facility for food import financing could be set up to alleviate constraints of financing and clearinghouse to ensure staple food imports are available. An international clearinghouse would decrease the risk of reneged contracts by exporters when there are tight supplies via guaranteeing contracts for the delivery of commodities such as grain. Governments could also commit to the prevention of export bans to avoid any supply disruption. However, it would be difficult to get governments to commit, especially when faced with commodity crisis Another proposal to stabilize price volatility requires structural agricultural transformation that will result in price stabilization but requires credible and transparent policies for price stabilization (Piot-Lepetit, 2011: p65). Public instruments would still be a necessity although they require to be modified to ensure equality for all countries, poor and rich. Under this rationale, instruments for risk management are necessary but are better utilizable by governments to protect from instability during public intervention implementation. There could be development of policies for price stabilization whose implementation would be at regional level, given the interconnected nature of food markets located in the same region. Market modernization would also have to happen at regional level factoring in the market and infrastructure institutions, for instance warehouse receipt systems, quality standards, and exchanges (Sarris, 2011: p59). The volatility in agricultural commodity prices could portend severe consequences on global grain market confidence, hampering its performance in its response to production costs, demand, and supply (Winters & Sapsford, 2010: p68). It could also result in unwanted and unreasonable fluctuations of the price that could lead to irreversible nutritional damage in developing countries. This highlights the importance to modify international agricultural and financial markets to address price spikes and dips. Overall, the most effective policies aimed at stabilizing agricultural commodity prices are the virtual reserves, the International Grain Clearance System, the regional reserves, and the internationally coordinated grain reserve system. These policies act as the most effective ones in the reduction of agricultural commodity price volatility, even though, they significantly vary in resources required for implementation, in addition with the amount of, research needed in the process of properly implement them (Winters & Sapsford, 2010: p68). References List Atkin, M., 2009. Agricultural Commodity Markets: A Guide to Futures Trading. London: Routledge. Cooke, B. & Robles, M., 2010. Recent food prices movements: A time series analysis. Washington: Intl Food Policy Res Inst. FAO., 2009. The State of agricultural commodity markets . Rome:Food and agricultural organization of the United Nations. Hill, C., 2011. Global business today. New York : McGraw-Hill. Hill, C., 2012. International Business: Competing in the Global Market Place. New York : McGraw-Hill Professional. Lines, T., 2011. Agricultural commodities, trade and sustainable development. London : International Institute for Environment and Development. Munier, B., 2012. Global uncertainity and the volatility of agricultural commodities prices. Amsterdam : IOS Press. Piot-Lepetit, I., 2011. Methods to Analyse Agricultural Commodity Price Volatility. New York : Springer. Sarris, A., 2011. Agricultural commodity markets and trade : new approaches to analyzing market structure and instability. Cheltenham : Elgar. United States Department of Agriculture, USDA. World Agricultural Supply and Demand Estimates (WASDE). August 2012. http://usda.mannlib.cornell.edu/MannUsda/viewDocumentInfo.do?documentID=1194 (accessed January 12, 2012). Winters, A. & Sapsford, D., 2010. Primary commodity prices : economic models and policy. Cambridge : Cambridge University Press. 2. Examine the economic and institutional challenges facing the survival of the euro currency, identifying the advantages to business of the single currency area and the problems that would be experienced if this breaks up. The Euro outlook in early 2012 was especially encouraging with confidence seemingly returning steadily with decisions taken calming the markets. However, pressures mounted once again, reflecting Greece’s and Spain’s difficulties, making it clear that the situation remains precarious and the solutions adopted had to undergo modification so as to be long term measures rather than short term ones (Cohen, 2012: p69). There are several positive signs, especially the reasonably buoyant nature of the bond market, the slight decline in yields for peripheral countries, and the improvement of the stock markets. However, two major weaknesses persist. One, financial markets have become highly fragmented with sovereign yield spread being significantly substantial and weak growth within the Euro area. The main challenge facing the Euro currency has to do with a lack of fiscal discipline by most member nations. While they had to make considerable efforts to consolidate and fulfill the criteria for convergence so as to be allowed to join the Euro, some have become lax on entering the single currency area (Beblavy? et al, 2011: p49). Some ran up debts and deficits including over times of significant growth and this results in no fiscal room and substantial deterioration of their public finances. Therefore, the individual discipline of member states has been too weak with collective discipline that is not applied in practice. The Stability and Growth Pact was initially designed to be the Euro monetary union’s fiscal pillar based on a mechanism of peer review. However, it has been misinterpreted; while countries are required to maintain, over the cycle, a fiscal balance that does not breach 3% GDP reference value, some interpreted it to mean they can constantly run a 3% deficit. In addition, the pact was not followed to the letter, as member states that breached its rules were not sanctioned (Desai, 2011: p68). The gap in competitiveness had also widened increasingly even before the crisis of 2008 began. When becoming a member of a currency area that states its goal as the achievement of Read More