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Banking

Commodity markets: A drop in a puddle

Commodity markets used to be dominated by producers and users hedging their production and consumption. Now the mass arrival of investors has profoundly transformed these relatively small and illiquid markets. Peter Koh reports.

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A DROP IN the ocean passes unnoticed but a drop in a puddle makes a big old splash.

Given that most commodity markets are decidedly more puddle-like in terms of size and liquidity than oceanic, it is hardly surprising that the buckets of cash that investors have been throwing at them have caused waves.

What is surprising, however, is how rapidly and profoundly investors have changed some of these markets, by displacing the producers and consumers of these goods as the most important players and either causing outright shifts in demand or amplifiying trends, with ripple effects.

Although commodity markets have always been volatile, investors have in some cases intensified volatility, increasing the cost of trading and the risk of market failure. In many ways, however, investment money has been a blessing. With more and more of people’s pensions at stake, regulators are starting to keep a closer watch.

Although some investors, particularly short-term technical hedge funds, have been active in commodities since the early 1990s, investment in commodities began to take on new proportions after the dotcom crash, starting its current meteoric rise only around 2004.

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