Commodity prices - role of speculative activity?

James Hamilton points attention to the sharp, across the board rise in global commodity prices and questions the popular perception that weakening dollar has been the main contributing factor. He argues that the magnitude of movements in commodity prices greatly exceeds the size of changes in the exchange rate - since the start of this year oil prices have increased five times as much as the dollar price of a euro. He attributes three reasons for the

1. The resurgence in real economic growth among the emerging economies, whose contribution to global economic growth have been growing, has increased demand for commodity prices and thereby driven up their prices and also put strengthened their currencies against the dollar.

2. Investors are making increasing use of commodities as an investment class to hedge against risks in equities and a depreciating dollar. Further, the low interest rates have also provided an incentive to hoard physical commodities as an investment vehicle.

He points to a paper by Ke Tang and Wei Xiong, which finds that contrary to the unrelated movements in oil and other commodity prices a decade ago, there is an increasing tendency for commodity prices to move together over the last few years. They attribute this to co-relation to "the increased use of commodities as a financial investment".

Correlation (using a rolling sample beginning one year before indicated date) between returns on oil and specified commodity. Source: Tang and Xiong (2009).

In this context, I had blogged earlier that the speculators driving up commodity (mainly oil) prices was not borne out by the inevitable increase in storage and inventories (since speculators are not end-users of the commodity, atleast a share of the commodities under speculation has to find its way into some form of rolling storage).

However, Jim Hamilton now points to the graphic below which shows considerable increase in oil inventories and also reports of speculation in commodities from different parts of the world. This appears to point to the growing influence of speculative activity on global commodity prices.

Weekly U.S. crude oil ending stocks, excluding SPR, in thousands of barrels, from EIA. Black line: average over 1990-2007. Red: 2008. Green: 2009.

Update 1
Moneywatch explains the reasons for oil price volatility.