Lim Hng Kiang: Issues, challenges and opportunities presented by
commodities
Speech by Mr Lim Hng Kiang, Deputy Chairman of the Monetary Authority of Singapore and
Minister for Trade and Industry, at the Global Financial Market Summit, Singapore,
9 July 2008.
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Introduction
I am very honoured to be invited to participate in this Conference on Global Financial
Markets and in particular on the commodity markets. High food and fuel prices continue to
hog the headlines nowadays. I am sure the proceedings of this Conference will attract strong
interest.
The commodities world
The importance of commodities cannot be over-emphasised. Commodities are the critical
raw materials that feed our peoples and our factories, and power our economies. In countries
where Governments have had to reduce fuel subsidies, this has sparked heated protests by
consumers and workers, from farmers to fisherman to truck drivers, causing economic and
social disruptions. Some have also likened the oil rally to the dot.com bubble and are wary of
a third oil shock since the 1970s and 80s.
Boom in commodity prices
What has led to the boom in commodity prices? The global increase in commodity prices has
been widely attributed to the mismatch between physical demand and supply. On the
demand side, there has been a significant increase in consumption of fuel and grain. In Asia,
demand for oil has been driven by tremendous growth in emerging markets such as India
and China. Globally, rising household income due to economic expansion has also led to
higher consumption levels. Increased demand for meat consumption as a result of rising
affluence means more grains are channeled from humans to animal feed while biofuels
diverted food from people to petrol tanks.
On the supply side, underinvestment in oil and gas exploration has caused output growth to
lag behind demand gains. Disruptions in Nigeria, Iraq, and declining production in Russia
have added to supply woes. Political tensions in the Middle East further threaten to reduce oil
taps. Climate change has also led to poor harvests of corn, soya bean and wheat. Regions
such as the US suffered from excessive rain while Australia underwent severe drought.
Soaring prices for fertilizer and diesel have also made it costly for farmers to plant, reducing
farm output.
Besides the economics of demand and supply, financial market dynamics might also have
played a part in fuelling the commodity price boom. Commodities have been found to be
uncorrelated or negatively correlated to traditional asset classes of equities and bonds,
therefore holding commodities in investment portfolios can reduce risk and enhance potential
returns. More recently, following the sub-prime fallout and relatively less attractive debt and
equity markets, some investors could have switched to commodities as an alternative
investment class, pushing up their prices further. As commodities prices rise, they in turn
attract non-traditional players to the market, adding to trading volume. According to BIS data,
global turnover in commodity derivatives (measured in number of contracts) grew from 420
million to 489 million in the first quarter of 2008. On a year-on-year basis, turnover grew 52%,
led by agricultural and energy products.
Others have pointed the finger at speculators for the historically high commodity prices
although the extent of this has not been well established. There are concerns over
speculative activities giving rise to a disconnect between the physical and futures markets. In
the US where commodities are actively traded, there are claims that speculators' interest in
crude oil now account for about 70% of all trading in West Texas intermediate crude on the
New York Mercantile Exchange ("NYMEX"), compared with 37% in 2000. On the other hand,
some have attempted to make a distinction between speculative trading (which at the core,
means taking positions based on one's view of the market) and market manipulation (or
collusive trading that interferes with the free play of demand and supply, and has an illicit
element). They argue that speculators play a vital role in providing liquidity and take the risk
that hedgers want to avoid. Without speculation, consumers would likely pay more for energy
and other commodities. Whatever the causes, whether physical demand and supply or
speculation, the world now has to grapple with higher commodity prices.
What are the implications and effects of the commodities boom? Clearly the hike in oil prices,
for instance has crimped the real incomes of households. This would hold back consumption
spending, and hence GDP growth, in the oil importing countries. Not surprisingly, the world
economy is expected to slow in 2008, led by the US and other developed economies, amidst
falling asset prices and tighter credit conditions as well. The US is weighed down by falling
house prices, weak consumer spending and continued credit market distress. Domestic
demand in Europe is expected to be subdued while softer external demand and the strong
Euro could constrain export growth.
Some slowdown is to be expected in Asia, although firmer domestic demand conditions
should offset some of the weakness in exports. The region would also be buoyed by
continued strong growth expected of China, India and the Middle East, which would help to
mitigate the impact of the softer G3 economies. Indeed, inflation has emerged as a bigger
concern in Asia, particularly among the faster growing economies I have just mentioned,
including Vietnam. Thus, governments and central banks in the region not only have to deal
with slower growth prospects, but also guard against rising inflationary pressures arising from
strong domestic monetary expansion as well as higher commodity prices.
High commodity prices would shape manufacturing decisions and define future trade flows.
Higher shipping costs from fuel hikes have eroded the wage advantage of low cost producers
such as China and Vietnam especially in inexpensive items that have high freight cost
relative to final sale price. For instance, it has become cheaper to manufacture steel in the
US, instead of importing them from China where steelmakers have to transport iron ore from
Brazil and Australia to the mills, and then ship the manufactured steel to the US. China has
also recently agreed to pay close to 100% more for its iron ore. The costs are likely to be
passed on to steel buyers and this could fuel inflation.
Rising commodity prices have also increased the prominence of commodities in the financial
markets. Commodity markets have in fact, become more financial market like. Traditionally,
financial activity in commodity markets focused on exploiting arbitrage opportunities, with
investors hedging their production or consumption in the futures market. The entry of new
market players such as banks and hedge funds, with their different risk appetite and
investment horizon, has given rise to varied trading strategies. They have also given birth to
a wider variety of financial instruments in the likes of index and exchange traded funds, as
well as structured commodity products. These new players also demand the sophistication
that they are used to in financial markets. As a result, commodity markets have moved
towards electronic trading, high speed communication links and greater efficiency in trade
processing. There is also an increasing need for infrastructure such as commodity
exchanges and clearing facilities to facilitate trading.
While market development is generally welcomed, the risks have to be managed. As
commodities become the flavour of the day, market participants should ensure that they
understand the risks as they participate more actively in the markets. In their eagerness to
ride the commodities wave, banks and other intermediaries should put in place appropriate
risk management systems and processes, ensure they have adequate resources including
qualified staff, and uphold proper market conduct. Investors too, should carefully evaluate
complex structures as they seek attractive returns.
Singapore as a commodities hub
Singapore has historically played an important role to connect importers and exporters.
Besides being strategically located, Singapore offers a high level of connectivity with its
efficient infrastructure and business friendly environment. Today, Singapore is a key aviation
and shipping hub, and an international financial centre. In the area of commodities, over 230
global trading companies have their offshore trading, marketing and procurement operations
in Singapore. We enjoy the reputation as the top energy trading hub in Asia, and is
increasingly a location of choice for other sectors including agri-commodities, metals and
minerals.
Singapore continues to be the hub for over the counter ("OTC") commodities derivatives
trading in the region, capturing more than 10% of global OTC commodities. In May 2006, the
SGX launched a central counterparty clearing facility or SGX AsiaClear, for OTC
commodities trading to mitigate counterparty risks and create efficiencies for the market
place. Today, SGX AsiaClear has seen growth in energy, freight and petrochemical
derivatives and potentially agriculture commodities.
We welcome further development of the breadth and depth of the commodities market and
infrastructure in Singapore. To strengthen our position as Asia's leading commodity
derivatives trading centre, we have taken measures to encourage the growth of the futures
market which would facilitate the price discovery process. Since February 2008, the
regulation of financial and commodity futures has been consolidated under MAS to facilitate
Singapore's growth as a futures trading hub. MAS has also reviewed the capital
requirements for brokers trading only in commodity futures contracts to ensure the relevance
of our capital requirements in light of developments in the commodity futures market. We
would continue to engage the industry as the market evolves to ensure our regulatory
framework remains robust, while offering a business friendly environment for commodities
trading.
Conclusion
The surge in commodities prices presents a challenge for the global community. The
Organisation for Economic Cooperation and Development sees agricultural commodity
prices retreating from peaks but rising up to 50% higher in the next decade. The UN Food
and Agriculture Organisation says food production must rise by 50% by 2030 to meet
demand and has warned that close to one billion people faced the prospect of hunger.
Commodities form the heart of a man's basic needs. World demand and supply of
commodities would find a balance in due course. Proper functioning markets, both physical
and financial, can help to make this adjustment and transition more efficient and less
disruptive. Towards this objective, we welcome a healthy development of the commodities
market in Singapore.
On this note, I wish you a fruitful discussion on the issues, challenges and opportunities
presented by commodities.
Thank you.