Summary: The 2006-08 commodity price boom was one of the longest and broadest of the post-World War II period. Apart from strong and sustained economic growth, the recent boom was fueled by numerous factors, including low past investment in extractive commodities, weak dollar, fiscal expansion, and lax monetary policy in many countries, and investment fund activity. At the same time, the combination of adverse weather conditions, the diversion of some food commodities to the production of biofuels, and government policies (including export bans and prohibitive taxes) brought global stocks of many food commodities down to levels not seen since the early 1970s. This in turn accelerated the price increases that eventually led to the 2008 rally.

The weakening and/or reversal of these factors coupled with the financial crisis that erupted in September 2008 and the subsequent global economic downturn, induced sharp price declines across most commodity sectors. Yet, the main price indices are still twice as high compared to their 2000 real levels, begging once more the question about the real factors affecting them.

This paper concludes that a stronger link between energy and non-energy commodity prices is likely to be the dominant influence on developments in commodity, and especially food, markets. Demand by emerging economies is unlikely to put additional pressure on the prices of food commodities. The paper also argues that the effect of biofuels on food prices has not been as large as originally thought, but that the use of commodities by financial investors (the so-called "financialization of commodities") may have been partly responsible for the 2007/08 spike. Finally, econometric analysis of the long-term evolution of commodity prices supports the thesis that price variability overwhelms price trends.

Commodity prices rose sharply again in August 2010 as crop production shortfalls in key producing regions and low stocks reduced available supplies, and resurging economic growth in developing and emerging economies underpinned demand. A period of high volatility in agricultural commodity markets has entered its fifth successive year. High and volatile commodity prices and their implications for food insecurity are clearly among the important issues facing governments today. This was well reflected in the discussions at the G20 Summit in Seoul in November, 2010, and in the proposals for action being developed for consideration at its June 2011 meeting of Agriculture Ministers in Paris.

This Outlook is cautiously optimistic that commodity prices will fall from their 2010-11 levels, as markets respond to these higher prices and the opportunities for increased profitability that they afford. Harvests this year are critical, but restoring market balances may take some time. Until stocks can be rebuilt, risks of further upside price volatility remain high. This Outlook maintains the view expressed in recent editions that agricultural commodity prices in real terms are likely to remain on a higher plateau during the next ten years compared to the previous decade. Prolonged periods of high prices could make the achievement of global food security goals more difficult, putting poor consumers at a higher risk of malnutrition.

Higher commodity prices are a positive signal to a sector that has been experiencing declining prices expressed in real terms for many decades and are likely to stimulate the investments in improved productivity and increased output needed to meet the rising demands for food. However, supply response is conditioned by the relative cost of inputs while the incentives provided by higher international prices are not always passed through to producers due to high transactions costs or domestic policy interventions. In some key producing regions, exchange rate appreciation has also affected competitiveness of their agricultural sectors, limiting production responses.

There are signs that production costs are rising and productivity growth is slowing. Energy related costs have risen significantly, as have feed costs. Resource pressures, in particular those related to water and land, are also increasing. Land available for agriculture in many traditional supply areas is increasingly constrained and production must expand into less developed areas and into marginal lands with lower fertility and higher risk of adverse weather events. Substantial further investments in productivity enhancement are needed to ensure the sector can meet the rising demands of the future.