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Heard On The Street
Commodities Go From Hoard to Floored
From the Wall Street Journal of Sun, 14 Dec 2014 14:06:00 EST
Keith Bedford for The Wall Street Journal (photo)

In understanding the latest commodities selloff centered on oil, consider a raw material lurking in your kitchen: rice.

Economists think stockpiling plays a big role in commodity bubbles, but are only now getting the evidence needed to understand exactly how it works. One implication of what they are learning: Prices haven’t bottomed yet.

A standard theory of how commodity bubbles form begins with an imbalance between supply and demand. This raises prices and prompts some stockpiling, due either to worries about having enough or hopes of selling for more in the future. This curbs supply further, pushing prices higher still. Cautionary stockpiling morphs into hoarding, and the bubble inflates.

Yet it is hard to see exactly how these bubbles play out, says Princeton University economist Harrison Hong, as commodity markets are complex networks of suppliers, middlemen and consumers.

When cotton hit 140-year highs in 2011, it was clear hoarding was happening, but nobody knew how much. Big producers including India and Brazil didn’t provide stockpile data. When The Wall Street Journal visited China’s Shandong province that January, farmers were storing thousands of pounds of cotton in their homes. Cotton has fallen about 70% from its peak.

Recently, though, researchers have accessed a huge data set on consumer behavior. For the Nielsen Homescan Panel, a partnership between Nielsen and the University of Chicago Booth School of Business, 100,000 U.S. households record the bar codes on every packaged item they buy.

Working with University College London economist Áureo de Paula and New York University economist Vishal Singh, Mr. Hong used the Homescan data to examine another bubble, in rice. This started in late 2007 when India, worried about food security, banned rice exports. Fears of shortages emerged and panic buying ensued. The U.S. didn’t face a rice shortage, but prices still shot higher, and people started to hoard. Costco Wholesale and Sam’s Club even started rationing bulk purchases.

The economists found some surprises. For example, while one might think lower-income households are more prone to panic over rising prices, those with higher incomes hoarded the most. Maybe they watched the news more closely or just had more money to buy rice.

The really odd thing was that a bunch of households who hadn’t bought rice before did so during the crisis, then never did again. They may have been reselling it, but more likely is that they just got swept up by the situation. Rice prices have fallen by roughly half since early 2008.

The takeaway: Commodity bubbles feed on irrational behavior and don’t last forever. Eventually, high prices encourage lower consumption and more supply. Prices ease, and stockpiles are run down. Middlemen who were looking to profit on perceived shortages start selling to limit losses.

Maybe they weren’t in a bubble, but the two largest commodity producing industries, oil and steel, are seeing something like that now as prices for crude and iron ore, used to make steel, tumble.

Now, imagine there was a bit more than just ordinary stockpiling going on. Driven by expectations that rising global consumption would keep outstripping supply, people got swept up into the same sort of scarcity mind-set as those peculiar rice hoarders.

Certainly, iron ore and other metals played a significant part as speculative collateral in the rapid boom in “shadow lending” in China that Beijing is now squeezing. In the U.S., there was an expensive land grab by exploration and production companies, financed by everyone from regional banks to private-equity firms, convinced that triple-digit oil was a given. That is now teeing up a potential crisis in the high-yield bond market.

As reality sinks back in, it is possible prices have a lot further to fall.

Sacks of rice at a grain market in India. When the nation banned rice exports in 2007, it kicked off a price bubble which offered academics clues about how other commodities bubbles work.
Sacks of rice at a grain market in India. When the nation banned rice exports in 2007, it kicked off a price bubble which offered academics clues about how other commodities bubbles work. Reuters

Write to Justin Lahart at

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