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Milton Friedman Proved Wrong by Aluminum Market

Author: Peter R. Orszag, Adjunct Senior Fellow
April 11, 2012
Bloomberg.com

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Commodity prices have fluctuated substantially over the past few years. The controversial question is, are financial speculators to blame?

In general, prices are determined by underlying forces of physical supply and demand. But with regard to at least one commodity -- aluminum -- and at least for brief periods of time, new research suggests that financial flows can indeed influence prices significantly.

Over the past decade, commodity prices have risen by an average of 9 percent a year, according to the composite index assembled by the Commodity Research Bureau. Aluminum prices, which have been through some dramatic ups and downs, have gained a bit less rapidly over that time. The average closing price for aluminum on the London Metal Exchange went from less than $1,500 per metric ton in 2001 to almost $2,400 in 2011 -- an increase of about 5 percent a year. (Disclosure: I have clients involved in both the production and use of aluminum.)

The vast bulk of the aluminum price changes can be explained by physical supply-and-demand factors, such as the cost of energy, opening of new supply basins at higher marginal costs and the increase in demand from China. At the same time, however, financial markets have become significantly more interested in aluminum. Over the past five or so years, trading in the material has roughly doubled. Daily volumes on financial markets are now 10 to 20 times the physical consumption of aluminum -- and market participants hold contracts that represent about half of world consumption, a large share even compared with other commodities.

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