Issue 3: Is speculation causing food prices to rise?

Although speculation is often blamed for causing problems in markets, the economic evidence shows that overall it is a necessary activity that makes markets more liquid and efficient. This, in turn, benefits hedgers, investors, and other market participants. Speculation increases market liquidity by reducing bid-offer spreads, by making it possible to transact more quickly at a given size, and by making markets more resilient. Without speculation, there would be fewer opportunities for other market participants, especially hedgers, to manage the risks they encounter in their financial activities.

FAO/IFAD/IMF/OECD/UNCTAD/WFP/World Bank/WTO/IFPRI/UN HLTF Policy Report

  • “Speculators are necessary for the performance of both these functions [transferring price risk and facilitating price discovery]. They buy and sell futures contracts and take on the risk of price fluctuations…By doing so, they provide the market liquidity which enables commercial hedgers to find counterparties in a relatively costless manner. Too little non-commercial participation results in low liquidity and potentially in large seasonal price swings.”

Dwight R. Sanders and Scott H. Irwin, New York Times

  • “Based on such data, it seems unlikely that speculators are dominating commodity futures markets. If speculation is driving prices above fundamental economic values, it is not obvious in the level of speculation relative to hedging. And there are additional reasons to doubt that speculation has led to bubbles in commodity futures prices.”
  • “The complex interplay of these factors and how they affect commodity prices is often difficult to grasp immediately, and speculators are a convenient scapegoat for the public’s frustration with rising prices. That’s unfortunate because curbing speculation — and hobbling the ability of businesses that rely on futures markets to reduce their risk — is counterproductive.”

Craig Pirrong, Streetwise Professor (April 2011)

  • “As yet there is no serious theory, and certainly no serious evidence that speculators have distorted commodity prices.”

IOSCO Report (March 2009)

  • “These reports suggest that economic fundamentals, rather than speculative activity, are a plausible explanation for recent price changes.”

European Commission First Interim Report

  • “Linked to the expected evolution in market fundamentals, which it characterized as an essentially positive feature of the market, facilitating price discovery and risk management for the investor, while providing a timely signal of the need for adjustments in structural supply and/or demand in the market” [while]…The second type of speculation can result in the emergence of a speculative bubble, reinforcing the fundamentals-based (and usually upward) price trend”

Interagency Task Force on Commodity Markets Interim Report

  • “The Task Force’s preliminary assessment is that current oil prices and the increase in oil prices between January 2003 and June 2008 are largely due to fundamental supply and demand factors. During this same period, activity on the crude oil futures markets – as measured by the number of contracts outstanding, trading activity, and the number of trades – has increased significantly. While these increases broadly coincided with the run-up in crude oil prices, the Task Force?s preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices.”

Craig Pirrong, Streetwise Professor (August 2009)

  • “Rice University’s Baker Institute has released a report on oil speculation, that concludes that increasing volumes of speculation have caused oil prices to be higher than they would otherwise be, and in a novel twist, have caused a higher correlation between the dollar and the price of oil. It also lays blame on everybody’s favorite whipping boy, the Commodity Futures Modernization Act of 2000. In a nutshell, this report is bilge. It relies on no rigorous economic analysis to support its contentions. Moreover, it is unscientific, eschewing any serious statistical analysis.”
  • “But it is odd indeed to argue that a massive increase in speculation caused higher oil prices when the bulk of this increase in speculation occurred in spread positions. Such positions, which involve the purchase and sale of oil for different delivery dates, are speculations on the shape of the oil forward curve, not on the absolute price level. Indeed, it is very difficult to imagine how such spread positions would cause prices to rise since they involve purchases and sales in equal magnitude.”

EDHEC-Risk Institute Paper

  • “What then is the economic role of commodity speculation and its ‘value to society’? Ultimately, successful commodity speculation results from becoming an expert in risk bearing. This profession enables commercial entities to privately finance and hold more commodity inventories than otherwise would be the case because commercials can lay off the dangerously volatile commodity price risk to price-risk specialists. Those commercial entities can then focus on their areas of specialty: the physical creation, handling, transformation, and transportation of the physical commodity.”
  • “Broadly speaking, past eras of grain price inflation, whatever the cause, resulted in devastating civilizational consequences. Over the centuries, two innovations have lessened these tragic episodes: international trade and the increase in inventory holdings. Commodity futures markets are a trial-and-error development that serves the latter civilizational advancement. If the existence of price-risk-bearing specialists ultimately enables more inventories to be created and held than otherwise would be the case, we would expect their existence to lead to the lessening of price volatility. To be clear, why would this be the case?”
  • “The more speculators there are, the more opportunity there is for commercial hedgers to find a natural other side for hedging prohibitively expensive inventories. This in turn means that more inventories can be economically held. Then with more inventories, if there is unexpected demand, one can draw from inventories to meet demand, rather than have prices spike higher to ration demand.”

Michael V. Dunn Opening Statement

  • “To date, CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the markets we regulate or that position limits will prevent excessive speculation.”

OECD Technical Report

  • “There is no convincing evidence that positions held by index traders or swap dealers impact market returns.”

Steve Johnson, Financial Times

  • “The argument of the antis is that speculative investment pushes up food prices beyond the level that intrinsic supply and demand would dictate. For all the huffing and puffing there is precious little evidence to support this.”
  • “If nasty speculators were buying up several Iowas worth of corn and squirreling it away in vast warehouses that would certainly move the spot price. But they are not, they are buying futures contracts.”
  • “To the extent that this steepens the forward price curve, it could be argued that it should stimulate greater production, eventually lowering prices.”
  • “However the existence of speculators has allowed politicians and campaigners to paint them as bogeymen and blame them for rising food prices. Removing speculation from the equation would simplify matters and, come the inevitable next spike in food prices, leave policy makers and special interest groups no option but to address the real issues that are causing demand to outstrip supply – namely an ever-spiralling (and increasingly wealthy) global population, climate change and, in too many cases, degradation of soil quality due to over-intensive production.”
  • “Given the huge importance of food security, the benefits of this scenario would massively outstrip the potential loss of a small source of return to the investment community.”

GAO Letter

  • “…the eight empirical studies we reviewed generally found limited statistical evidence of a causal relationship between speculation in the futures markets and changes in commodity prices”
  • “…similar to the studies that used the public COT data, the studies using the nonpublic data also found limited evidence that speculation was affecting commodity prices. In addition, all of the empirical studies we reviewed generally employed statistical techniques that were designed to detect a very weak or even spurious causal relationship between futures speculators and commodity prices. As result, the fact that the studies generally did not find statistical evidence of such a relationship appears to suggest that such trading is not significantly affecting commodity prices at the weekly or daily frequency.”

US Foreign Affairs Report

  • “U.S. officials, both in Congress and in the executive branch, should take care not go too far, however, and prescribe overly harsh limits on speculative bets on energy futures or set other costly barriers for firms that need to hedge. A blanket crackdown on speculation would only increase the exposure of firms and consumers to volatility by shrinking financial markets and chasing hedging to less transparent and less regulated venues.”

Craig Pirrong, The Wall Street Journal

  • “First, consider the charge that commodity prices are being “manipulated.” There are of course certain well-known forms of market manipulation — notably the “corner” or “squeeze.” Here a trader buys more futures contracts than there is commodity to deliver, and forces those that have sold to him — but who cannot deliver — to buy back their contacts at an exorbitant price. None of this has been observed in the oil markets in recent months. Even more to the point, manipulations of this sort typically have short-lived effects on prices. They cannot account for the extended run of high oil prices.”

OECD Food, Agriculture and Fisheries Working Paper

  • “…While the increased participation of index fund investments in commodity markets represents a significant structural change, this has not generated increased price volatility, implied or realised, in agricultural futures markets. Based on new data and empirical analysis, the study finds that index funds did not cause a bubble in commodity futures prices. There is no statistically significant relationship indicating that changes in index and swap fund positions have increased market volatility.”

Paper Presented at the Southern Agricultural Economics Association Meetings

  • “..Simply observing that large investment has flowed into the long side of commodity futures markets at the same time that prices have risen substantially (or the reverse) does not necessarily prove anything. This is more than likely the classical statistical mistake of confusing correlation with causation. One needs a test that accounts for changes in money flow and fundamentals before a conclusion can be reached about the impact of speculation.”
  • “There is little evidence that the recent boom and bust in commodity prices was driven by a speculative bubble. If speculation by long-only index funds did impact commodity futures prices, it is not evident in the empirical evidence available to date. Economic fundamentals, as usual, provide a better explanation for the movements in commodity prices. The main factors driving prices up in the energy markets included strong demand from China, India, and other developing nations, a leveling out of crude oil production, a decrease in the responsiveness of consumers to price increases, and U.S. monetary policy.”
  • “The complex interplay between these factors and how they impact commodity prices is often difficult to grasp in real-time and speculators have historically provided a convenient scapegoat for frustration with rapidly rising and falling prices.”
  • “…limiting the participation of index fund investors would rob the markets of an important source of liquidity and risk-bearing capacity at a time when both are in high demand. The net result is that commodity futures markets will become less efficient mechanisms for transferring risk from parties who don’t want to bear it to those that do, creating added costs that ultimately get passed back to producers in the form of lower prices and back to consumers as higher prices.”

IOSCO Report (September 2011)

  • “..The Task Force’s 2009 review of available literature led it to conclude that existing economic research “[did]” not support the proposition that the activity of speculators has systematically driven commodity market cash (physical) or futures prices up or down on a sustained basis.”

Madison Marriage, Financial Times

  • “Matthew Kerfoot, a partner at law firm Dechert, says: ‘Every time a commodity such as oil increases in price, suddenly there is a clamour among politicians concluding that commodities speculation is responsible. This is a knee-jerk reaction from politicians who point their fingers at the commodities market, but there is no evidence ever cited to support that conclusion.’”