Tag Archives: speculation

Food security and financial markets

FAO says that Food price volatility a major threat to food security:

Concluding a day-long special meeting in Rome the experts recognized that unexpected price hikes “are a major threat to food security” and recommended further work to address their root causes.

The recommendations, put forward by the Inter-Governmental Groups (IGGs) on Grains and on Rice, came as FAO issued a report showing that international wheat prices have soared 60-80 percent since July while maize spiked about 40 percent.

The meeting said that “Global cereal supply and demand still appears sufficiently in balance”, adding, “unexpected crop failure in some major exporting countries followed by national policy responses and speculative behaviour rather than global market fundamentals have been the main factors behind the recent escalation of world prices and the prevailing high price volatility.”

Among the root causes of volatility, the meeting identified “Growing linkage with outside markets, in particular the impact of ‘financialization’ on futures markets”. Other causes were listed as insufficient information on crop supply and demand, poor market transparency, unexpected changes triggered by national food security situations, panic buying and hoarding.

The Groups therefore recommended exploring “alternative approaches to mitigating food price volatility” and “new mechanisms to enhance transparency and manage the risks associated with new sources of market volatility”.

In a recent IFPRI discussion paper, Recent Food Prices Movements: A Time Series Analysis, Bryce Cooke and Miguel Robles analyze the food price spike of 2008.  They asses multiple proposed explanations (from biofuels, oil prices, weather, trade barriers, and speculative markets) using econometric time series analysis.  They conclude that financial activity in futures markets and proxies for speculation can best explain crisis.  They write:

Results of our rolling windows Granger causality tests show the following:

(1) In the case of rice prices we find weak evidence that for few 30-month intervals between 2004 and 2007, the U.S. dollar depreciation rate has marginally Granger-caused the growth rate of rice price; and also the growth rate of real world money holdings seems to be more important in explaining the growth rate of rice prices after 2004, but this evidence is not really statistically significant.

(2) When we analyze the price of soybeans we find that, starting in mid-2005 (which implies a 30-month period ending December 2007), the growth rate in the world exports of soybeans shows evidence of Granger causing the growth rate of soybean prices.

(3) In the case of corn we find that starting in the second half of 2004 the growth rate of oil prices shows evidence of Granger causing the growth rate of corn prices, but with a negative relationship.

(4) When analyzing our speculation proxies we observe that the ratio of monthly volume to open interest in futures contracts indicates that for the case of wheat and rice, starting in 2005, it has influence in forecasting price movements.

Also we find that for the case of rice, the ratio of noncommercial long positions to total long (reportable) positions has an effect on prices, starting in 2004. When we analyze the same ratio for short positions we find additional evidence for speculation affecting the growth rate of corn and soybean prices. In the case of corn there are signs of causality between March 2004 and September 2006, and during the 30-month span from May 2005 to November 2007. In the case of soybeans we find weak evidence, in particular for the 30-month period ending February 2008.

Interestingly as the rolling samples include 2008 and 2009 data, picking the decrease of grain prices since mid 2008 and the adverse effects of the global financial crisis, the evidence of speculation activity affecting spot prices vanishes in all cases. This supports the view that during the food crisis agricultural grain markets were operating under a different regime in which speculation activity played a role in spot prices formation. The overall evidence points to the following interpretation: before and after the food crisis speculation activity had no effect on spot prices formation while during the crisis it did. This is not to say that before and after the crisis speculation was not present, it was (probably to a less extent) but didn’t granger cause spot prices.

Overall, we conclude from our time series analysis that when taking the four commodities analyzed here there is evidence that financial activity in futures markets and/or speculation in these markets can help explain the behavior of these prices in recent years. Other explanations are only partially supported for the particular case of one agricultural commodity or not supported at all. We do not claim, however, that these other explanations should be disregarded; all that we can say is that in using the variables considered in this study and the particular time series models herein, we do not find such evidence.

Frederick Kaufman wrote a Harper’s magazine in July 2010 The food bubble:
How Wall Street starved millions and got away with it
that reports on finance and the food crisis. The Harper’s version is behind a paywall, but Kaufman was interviewed on Democracy Now.

More academic takes on the food crisis and the possible future of food price volatility are in:

C. Gilbert and C. Morgan’s article Food price volatility in Proc Royal Soc (DOI: 10.1098/rstb.2010.0139 ). They conclude:

We have highlighted the extensive evidence demonstrating interconnection of financial and food commodity markets as the result of speculative activity. Nevertheless, this contention remains controversial and, until the mechanisms are better understood, the policy debate will remain confused.


C. Gilbert’s How to Understand High Food Prices in Journal of Agricultural Economics (DOI: 10.1111/j.1477-9552.2010.00248.x) whose abstract states:

Agricultural price booms are better explained by common factors than by market-specific factors such as supply shocks. A capital asset pricing model-type model shows why one should expect this and Granger causality analysis establishes the role of demand growth, monetary expansion and exchange rate movements in explaining price movements over the period since 1971. The demand for grains and oilseeds as biofuel feedstocks has been cited as the main cause of the price rise, but there is little direct evidence for this contention. Instead, index-based investment in agricultural futures markets is seen as the major channel through which macroeconomic and monetary factors generated the 2007–2008 food price rises.

A giant pool of money flows into global agriculture

As part of its interesting Food Chain series, the New York Times writes Food Is Gold, So Billions Invested in Farming about how investment funds are pouring billions of dollars into agriculture. One investment bank has estimated that investments in agricultural commodities has increased over 3X, from $70 billion at the start of 2006 to $235 billion in April of 2008, with roughly half of this growth being due to appreciation and half to new investment (for more details see Financial Times on agricultural funds and why food prices are rising?). However, money is now moving from investments in commodity futures into actual agricultural infrastructure:

Huge investment funds have already poured hundreds of billions of dollars into booming financial markets for commodities like wheat, corn and soybeans. But a few big private investors are starting to make bolder and longer-term bets that the world’s need for food will greatly increase — by buying farmland, fertilizer, grain elevators and shipping equipment.

Part of the article is reminiscent of the TechnoGarden scenario of the MA, in which rich companies invest in the underdeveloped African agriculture infrastructure. The article states:

Emergent is raising $450 million to $750 million to invest in farmland in sub-Saharan Africa, where it plans to consolidate small plots into more productive holdings and introduce better equipment. Emergent also plans to provide clinics and schools for local labor.

One crop and a source of fuel for farming operations will be jatropha, an oil-seed plant useful for biofuels that is grown in sandy soil unsuitable for food production, Ms. Payne said.

“We are getting strong response from institutional investors — pensions, insurance companies, endowments, some sovereign wealth funds,” she said.

The fund chose Africa because “land values are very, very inexpensive, compared to other agriculture-based economies,” she said. “Its microclimates are enticing, allowing a range of different crops. There’s accessible labor. And there’s good logistics — wide open roads, good truck transport, sea transport.”

However, unlike the TechnoGarden scenario, this investment seems focussed on increasing yields of food and fuel, rather than producing multiple ecosystem services. Consequently, such investments attempts to increase yields by practicing intensive agriculture are likely to lead to negative impacts on other people and ecosystems using water, and potentially leading to local or regional ecological regime shifts (see our paper Gordon et al 2008).

Also, many of these investments are not aimed at increasing agricultural yield on the ground, but hedging against inflation risk, and providing market power for large funds to leverage investments in other financial instruments, such as options, derivatives and other more complicated packages. This coupling of financial markets, to the already coupled food, fuel, and climate systems means that the systemic consequences of these investments are likely to be unexpected and novel.