Volatility cuts both ways

Lest we be lulled into the assumption that commodity prices are on a one-way trip to infinity:

In just the last couple weeks corn prices have fallen from nearly $8/bushel to about $6.15. All of that is due to a rather small amount of information about the progress of this year's crop. Yes, there were reports of flooding and late plantings, but that kind of thing rarely has much effect on the overall crop production. The late plantings just set up even more volatility going forward, since the plants will be susceptible to extreme heat in July and August.

That's Michael Roberts, who concludes that

this volatility does provide a teachable moment: it shows how sensitive prices are to small quantity changes.

True, but I think we are collectively more attuned to the downside factors (climate change, growing demand) than the potential upsides (e.g., a sudden removal of biofuels mandates, or a restoration over several years of typical buffer stock levels). A 25% fall in a matter of weeks is huge, and a reminder that high food prices and food price volatility are not the same thing (a huge pet peeve of mine).

This can also be true for seemingly exhaustible physical resources, as yesterday's announced discovery of "vast deposits of rare earth metals" on small plots of Pacific Ocean seabed show us.

estimated rare earths contained in the deposits amounted to 80 to 100 billion metric tons, compared to global reserves currently confirmed by the U.S. Geological Survey of just 110 million tonnes that have been found mainly in China, Russia and other former Soviet countries, and the United States.

(don't sleep on the B vs. M - that is 800-1,000x current confirmed reserves)

I am pondering a longer post on what this means for commodities as an asset class (namely that over decades, they will not provide attractive real returns, although they may have some value as a hedge against inflation).

Finite room for construction in China

China's explosive demand will finally drop from its stratospheric level, either because China's economic development falters or because China is finally totally covered over in cement.

That is Rick Bookstaber, a deeply thoughtful blogger on financial markets, in response to Jeremy Grantham's newsletter on "the mother of all paradigm shifts" (i.e., "Days of Abundant Resources and Falling Prices Are Over Forever"), which excited the likes of Cowen and Krugman.

Like Rick I am in the less apocalyptic camp, although for much prosaic reasons (he believes that eventually our resource consumption will decrease as we increasingly lead virtual lives and turn away from material consumption). As Tyler Cowen says, China cannot continue to invest 50% of its GDP forever. There is a long way to go for the world to catch up to rich-world consumption levels, but it also won't happen all at once (apply an optimistic GDP growth rate to your favorite sub-Saharan African country and you'll be shocked at how long it will take to get where China's income is today, even if everything goes well). Resource demand may not be curbed any time soon, but ultimately I have more faith in the power of prices and markets to change behavior than the doomsayers seem to.

Julian Simon got lucky (or not)

Paul Kedrosky re-analyzes the famous Simon-Ehrlich bet on commodity prices, and concludes that Simon (who won) got lucky.

It will surprise no-one that the bet’s payoff was highly dependent on its start date...

Simon was right but fairly lucky. There is nothing wrong with being lucky, of course, but compulsive Simon/Ehrlich-citers need to be reminded that it is no law of nature (let alone of rickety old economics) that commodity prices (inflation-adjusted or otherwise) trend inexorably downward, even over a decade.

Here's how the bet would have turned out since:

Via MR, and by the way, I am a bit confused by Alex Tabarrok's take - he seems to say that Ehrlich was betting on "scarcity", but instead the "value" of commodities has since gone up as developing countries got richer, increasing demand. He is the economics professor, but isn't the cardinal precept of economics that scarcity and value are fundamentally linked?

Update: Or not... Mark Perry responds:

I'm not so sure that Simon was just lucky. If Simon's position was that natural resources and commodities become generally more abundant over long periods time, reflected in falling real prices, I think he was more right than lucky, as the graph above demonstrates.

Stated differently, if Simon was really betting that inflation-adjusted prices of a basket of commodity prices have a significantly negative slope over long periods of time, and Ehrlich was betting that the slope of that line was significantly positive, I think Simon wins the bet.