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. * * * 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

##ed 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.