Yes I know prices for commodities are up, and yes there is growing demand. Yes the bakers are going to demand things from their government. But in the face of all this I don’t buy the commodity rally. Here’s why.

My father-in-law is a potato farmer, his father was a farmer as well, and I had a long talk with my wife about this. I thought since they had been commodity providers for nearly a hundred years there should be some insight. The insight she gave me was what I surmised.

When my father-in-law grows potatoes he signs contracts ahead of time so that he gets a fixed price regardless of the conditions. This is both boon and bane because when free market conditions are good it means that there are not enough potatoes and the price goes up. In this situation the free market would have been better. Yet when there are plenty of potatoes the price goes down and the free market is a bane for the farmer.

The point is that the farmer and consumer of the goods arrange an agreement ahead of time and it has worked well. Yes the free market prices affect the arrangement agreement that is renegotiated every year, but there is a fixed price. So now comes the question does this apply to other markets? Let’s look at iron ore.

An increase of 18.62 per cent was agreed between the world’s largest iron ore producer, Brazil’s CVRD, and the world’s largest steel producer, Europe’s Arcelor, and then matched on Wednesday by deals between Australian and Japanese negotiators.

And there it is, both parties arranged a price between the producer and consumer. So that means if iron was to spike it does not MATTER because the contract is already arranged. The only thing that will happen is that Arcelor will increase its prices and blame the free market for high prices. The real problem is with companies that did not negotiate a contract.

For those tempted to play commodities be forewarned! If you buy a future and the future expires you better back up a truck somewhere because you just took ownership of whatever commodity you traded. I am saying this because many traders like to play games just before expiry causing you to loose all your gains.