The Hindu Business Line : Price discovery mechanisms

Commodities trading futures is one of the best ways to discover the price. It is supposed to help determine the price based on the demand-supply situation.

No one has any disagreement on this. But there are some extraneous factors that influence the trade decision, in an exchange which influences the movement of prices in the short-to-medium term. Commodities, world-wide, are classified as an asset class, thanks to the robust settlement mechanisms put in place by international and national exchanges.

Technology has been leveraged to make it possible to trade from the comfort of your home or office and far away from the ‘ring’ or auction market or warehouse. It is this environment that brings in risk-seeking capital into commodities and influence its prices.

We need to moderate this influence in commodities, especially agri commodities, or else we could build another potential disaster.

Liquidity and the trade it generates, looking for short-term profits, always tends to distort the price. It may lose its stream if it is not based on the basic fundamentals of demand-supply mismatch. But if the trend is based on sound fundamentals, it will definitely attract more money and push the prices to arrive at a balance price. All these bring in bouts of volatility, as seen in the prices of metals and some agri commodities.

We can do without all this volatility. Price discovery mechanisms cannot fuel volatility and it is here the exchange authorities have to comfort the policy-makers.

The LME has failed to do this and has allowed the local interest of London, being the global financial hub, to influence its decision in not curbing the volatility in metals prices.

Given the marginal cost of close to $3,000 per tonne of copper, it allowed the price to go as high as $8,800.

The many tools that they had in place, including altogether halting forward trading on an advance date, were not used. Now, the UK economy, as a whole, is disillusioned.

It is time the authorities, setting aside prejudices, resolve the disenchantment with the systems and bring in a measure of conformity to stabilise the market and help discharge the primary function of effective price discovery mechanism.

Balakrishnan V. e-mail

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