The Next Derivative Bubble by James Fournier

In my view the freight derivative market will produce the next major bubble with volume increasing in correlation with rising commodity prices. With finite supply and ever growing demand (from the likes of emerging markets), commodities are likely to see spectacular price increases in the next decade led by oil and base metal price increases in conjunction with expanding global economies. Legendary investor Jim Rogers shares this view stating commodity bull runs have lasted 15-20 years...We have got another nine to 17 years to go. Indeed, whether in a boom time or a recession different commodities will always be in high demand. In light of this, from a practical standpoint the use of Forward Freight Agreements and Container Freight Swap Agreements will be primarily used by shipowners and operators, oil companies, trading companies and grain houses as tools for managing freight rate risk. Shipping companies and raw material producers will use derivatives to hedge against volatile costs - namely the rising price of oils on freight fuel costs. Advantageous for the makers of bulky lower-value goods such as furniture, toys and machinery, the ability to hedge shipping costs should help them to outperform competitors and increase profitability. If further developed and globalized, the market could soon become as liquid as currency markets. Betting on container rates, which are a proxy for economic activity, may also appeal to speculators who could profit from the price fluctuations of such agreements similar to the widespread trading of credit default swaps that already occurs in financial markets. A whole host of SIVs could be created involved in the moving of excess supply around the global marketplace to high price areas for profit. Yet this will also create the systematic risk of potentially increasing food prices for consumers as suppliers are priced out of the market by container hungry firms. Clearly, global industry oversight will be needed to avoid the repercussions seen in the credit markets in 2008/2009. Looking back it seems that Enron were way ahead of their time in the trading of derivatives. Although the main commodities offered on Enron Online were natural gas and electricity, there were 500 other products including credit derivatives, bankruptcy swaps, pulp, gas, plastics, paper, steel, metals, freight, and TV commercial time. Perhaps in reality the next bubble will not occur in any specific market, but in the explosion of the use of derivatives by global investors to speculate on any tangible global commodity or indeed anything perceived to have value. This could include anything from drinking water, to internet bandwidth to telephone minutes - the possibilities are truly endless. Investment banks that can facilitate and create these markets in the same way J.P.Morgan created the credit derivative market in 1994 or Solomon Brothers who created the junk bond market and mortgage backed security OTC market in the 1970s - stand to profit highly in the next decade.