JOHN FAN AND NEDA TODOROVA |
Commodity price bubbles can have a huge impact on economies, but what exactly causes them? In simple terms, a price bubble occurs when the price of a commodity (like oil, metals, or grains) gets far higher than what it’s worth. This is often driven by speculation rather than actual demand or supply, and when reality catches up, the bubble bursts—leading to a dramatic drop in prices.
This blog explores what drives these bubbles in global commodity markets, particularly in China, and how they may affect both producers and consumers worldwide.
What is a commodity price bubble?
A bubble occurs when the price of a commodity becomes inflated well beyond its fundamental value. The price rise isn’t driven by supply and demand, but rather by speculative trading—investors betting on future price increases. Eventually, prices hit a peak and then crash, sometimes leaving significant damage in their wake. Think of it as an economic boom followed by a bust, with massive losses for those caught in the downturn.
Commodity price bubbles don’t happen often, but when they do, they can disrupt entire sectors, affecting everything from farmers to insurers.
The global picture: What causes these bubbles?
Globally, positive price bubbles are usually triggered by factors like low inventories, strong exports, or rapid economic growth. On the other hand, negative bubbles, where prices plummet, are often driven by pessimism in the market, like fears about economic downturns or falling demand.
In many cases, global commodity price bubbles are influenced by rational factors like inflation, inventory levels, and economic growth. This is where traders respond to changes in supply and demand. However, these bubbles are still short-lived because the markets eventually correct themselves.
The Chinese market: A unique case
China’s commodity market operates a little differently. Here, we see a much stronger influence of retail traders (small, individual investors) and excessive speculation. Because of this, China’s market is more prone to bubbles driven by emotional or irrational behaviour—like herding, where investors simply follow what others are doing, or overconfidence.
The speculative nature of China’s market means that price bubbles can form even when the demand for a commodity isn’t increasing. This makes the market more volatile, with bubbles forming and bursting more quickly than in other countries.
Comparing China and the world
Our research shows that in China, bubbles are more driven by the behaviour of investors than fundamental factors. For example, fear and uncertainty among traders can cause negative price bubbles. In contrast, globally, price bubbles are more likely to arise from rational responses to economic changes like inflation or inventory levels.
Interestingly, when positive price bubbles form in China, they can spread to global markets. This contagion effect suggests that Chinese market movements can have a ripple effect on the rest of the world.
Turning to the impact on negative bubbles, we find that negative price bubbles in Chinese commodities are not influenced by changes in trading volume, whereas the opposite holds true for global markets, resulting in a statistically significant difference between the two regions.
Why should we care?
Commodity price bubbles can significantly disrupt economies, increasing inflation and complicating risk management for producers, consumers, and insurers. When prices soar, it’s not just investors who are affected—farmers, manufacturers, and even consumers feel the impact.
In China, the persistence of speculation-driven bubbles highlights the need for regulatory attention. By curbing excessive speculation, regulators can help prevent extreme price swings and protect both local and global markets from unnecessary turmoil.
Conclusion: Bubbles, behaviour, and markets
In the end, commodity price bubbles are often the result of both economic factors and investor behaviour. While global markets tend to react more to fundamentals like supply and demand, China’s market is particularly susceptible to speculative bubbles driven by emotional responses. As these bubbles burst, they can have far-reaching consequences, not just for traders but for entire industries and economies.
By understanding the factors that drive these bubbles, market participants and regulators can better prepare for—and potentially mitigate—the damaging effects of these market swings.
Dr John Fan and Dr Neda Todorova are members of the Griffith Asia Institute, Dr Adrian Fernandez-Perez is from University College Dublin, Ireland and Dr Ivan Indriawan is from University of Adelaide, Australia.
This article is a synopsis of the journal article, “When Chinese mania meets global frenzy: Commodity price bubbles“ published in the Journal of Commodity Markets, written by John Hua Fan, Adrian Fernandez-Perez, Ivan Indriawan and Neda Todorova.
