Speculation Drives Up Food Prices as Bankers Gamble on Hunger

The Speculative Scrum Driving Up Food Prices

December 21, 2011

Guardian - Bankers, hedge funds and sovereign wealth funds are gambling on hunger by speculating on food supply. Global regulators should step in to stop them.

Last year, the price of global food floated high as ever. That's bad news for most of us, but not for those who trade commodities. In fact, 2011 was a great year for the traders, who thrive on bad news, currency woes, drought, flood, freeze, fire and all other manifestations of imminent apocalypse.

2011 was a wild ride. 

One spring morning, cocoa futures dropped 12% in less than a minute. Corn ascended to all-time peaks and sugar fluctuated more in one day than it used to in a month. Howard Schultz, CEO of Starbucks, railed against speculators in coffee, while PepsiCo forecast its own medium-term commodity cost increases to exceed $1bn. All of which meant a bumper crop for the world's commodity exchanges – even those that used to be backwaters, like the Kansas City Board of Trade and the Minneapolis Grain Exchange, both of which recorded their highest electronic trading volumes in history.

It was a volatile year, and the volatility posed problems for the food industry. Faced with a high-stakes game of price-shifting basic ingredients, the world's largest food processors and retailers put out the call for maths PhDs and economic modellers to theorise and implement ever-more complex risk-management strategies just so they could keep up with the second-by-second spikes and dips of grain and livestock futures. In the meantime, high-frequency traders and momentum-driven hedge funds made it their business to speculate on food.

There were plenty of ways to get in on the action, but as an increasingly complex amalgam of food-based commodity derivatives piled one on top of the other, the more difficult it became to perceive what it was that lay at the bottom of the speculative scrum. What drove the global food market in 2011 – other than those old faithfuls, fear and greed? I put in a call to Professor Yaneer Bar-Yam, of the New England Complex Systems Institute (Necsi), to see if he might have an answer.

Necsi, based in Cambridge, draws on fields as various as maths, physics and computer science to provide new perspectives on – and perhaps even solve – pressing problems in economics, healthcare, international development, and military and ethnic violence. Last year, Bar-Yam and his colleagues published a paper called The Food Crises: A Quantitative Model of Food Prices Including Speculators and Ethanol Conversion, in which the Necsi crew mathematically isolated and quantified the effects of speculation as a driving force behind the bull market in global food derivatives.

"Prices have been way out of equilibrium in 2011," Bar-Yam told me. "The bubble has not burst yet."

According to Bar-Yam, the international thirst for biofuels has put a strain on arable land previously reserved for food production. At the same time as the rise of the biofuel mandate, the rise of investable commodity indexes and other electronically traded funds has offered investors of all stripes a chance to sink their cash in a sparkling new casino of derivative products. As a result, an ever-flowing spring of speculative capital sustains the status quo.

But just as food is no ordinary widget, speculation in commodity markets is not simply a matter of financial predation.

"The high prices of food have resulted in accumulations of inventories at the same time as people can't afford food," said Bar-Yam, who noted that the Arab spring was triggered by the food-price bubble.

In fact, Necsi's quantitative model of speculation predicted the uprisings in Tunisia, Libya and Egypt, and warned that if food prices remain inflated, riots and revolutions will go global sometime between July 2012 and August 2013.

"We are at a critical point," said Bar-Yam. "We don't have a stay-the-course option right now."

He believes the time has come for global regulators to step in and manage the global market. Their first task would be to guarantee transparency and make public information previously shrouded in secrecy – such as who holds the biggest stakes in global commodities. Transparent accounting practices would have made the disappearance of $1.2bn worth of customer money from the books of MF Global less a matter of sleight of hand and more a matter of international crime.

The second part of the speculation solution hinges on a return to traditional position limits in commodities, limits enforced by international laws geared to stop bankers, hedge funds and sovereign wealth funds from going long on the world's food supply and, in effect, gambling on hunger.

Nothing influences financial regulators like equations, so the reforms we can look forward to in 2012 will ultimately depend on the numbers. Which is a mixed blessing.

"One reason people don't want to understand the math is the deafness of those who are making the money," said Bar-Yam. "But the old mathematics is manifestly wrong."

Financial Speculators Responsible for Rising Global Food Prices, Claims Report

Influence of financial players on agricultural commodity markets blamed for global food price inflation and hunger

September 13, 2011

Guardian - The activity of financial speculators is overwhelming agricultural commodities markets, fuelling global food price inflation and hunger, according to new analysis from the anti-poverty group the World Development Movement (WDM).

Its report, Broken Markets, published on Tuesday, finds that financial speculators with no interest in the physical goods traded now dominate agricultural commodity markets. WDM's report coincides with news that food inflation in the UK was running at 6.2% (pdf) in August. Annual inflation on bread and cereals was even higher, at 7.1%, compared to headline inflation of 4.5%, according to figures just released by the Office for National Statistics.

WDM says the spiralling food prices are being driven by financial players taking over commodities markets. Those on low wages in the UK and the poorest in developing countries are hit hardest, since they spend a larger proportion of their income on food.

Financial speculators now account for more than 60% of some agricultural futures and options markets, compared to just 12% 15 years ago, the development group says. Those with direct commercial interests in food production used to be the main participants, but now hold less than 40% of the market compared with 88% in 1996. The result is that agricultural markets no longer respond to underlying fundamentals of supply and demand and fail to provide producers with an effective way to hedge their risks.

"Financial speculators have flooded food commodity markets, creating massive inflation and sudden price spikes. These broken markets are bad news for people in the UK, whose average annual food bills increased by £260 in one year alone. But for people in poverty in developing countries, price rises are disastrous," the report's author, Murray Worthy, said.

WDM is calling for the UK government to stop blocking proposals in Europe to reform the markets.

The role of excessive financial speculation in the recent sharp rises in food prices has been controversial. The commodities exchanges and some analysts have argued that price rises and swings are the result of increasing demand and tightening supply. Christian Aid (pdf) and Oxfam have, however, also pointed to a huge rise in speculative flows as one cause of the global food crisis.

The WDM report identifies several types of investment made possible by deregulation in the past decade, each of which it believes is distorting the markets:

• Commodity index funds, which allow institutions such as pension funds to bet against movements in commodity prices. These funds are "long only", which means they only take positions speculating that prices will rise and they "roll" their positions, replacing contracts each month to maintain the same position in the market. These "massive passives" do not respond to the underlying fundamentals of supply and demand and so distort agricultural markets, WDM says.

• Computerised high-frequency trading is adding to the volatility of prices and has led to "flash crashes" in the sugar and cocoa markets. In this kind of trading, past price movements are analysed and used for algorithmic trading for very short periods of time. For example, when prices of sugar and cocoa started to fall in late 2010 and early 2011 respectively, they triggered the computerised models to sell automatically, fuelling a downward spiral that saw sugar fall by 11% and cocoa by 12.5% in a single day.

• Commodities exchanges now make their profit from the numbers of trades made, meaning they have a strong incentive to promote greater volumes of these sorts of speculative activities.

• Over-the-counter trading, which takes place outside the regulated exchanges, has boomed. At present, only commodity futures and some options are traded on exchanges. The rest of the derivatives market is traded through unregulated bilateral deals between institutions such as banks and pension funds. Over-the-counter trading bypasses the requirement on the exchanges for traders to post margins, ie put up a sum of money to cover the risk they are taking on any contract. This absence of transparent risk management creates dangerous bubbles, according to WDM.

In the past five years, the total assets of financial speculators in these markets have nearly doubled, from $65bn in 2006 to $126bn in 2011.

The largest contributions to food price inflation in the UK came from bread and cereals, meat (for which prices rose by 7.1% over the 12 months to August), mineral waters, soft drinks and juices (with a 9.4% rise), and sugar, jam, syrups, chocolate and confectionery, for which prices rose by 7.6%.