Trading of agricultural commodities, as plain assets, has considerably increased over the last few years, both on organized markets and on over-the-counter markets, which has led to unbridled speculation on agricultural commodities.
Dirk Müller of Finance Ethics Ltd examines this trend in a critical analysis (excerpts included below), published as part of one of the latest reports issued by the CNUCED, and eloquently titled: ‘Wake up before it is too late’1
Transactions operated on OTC markets artificially increase prices, owing to their prominent position on commodity derivative and cash markets, and generate profits for speculators and investors. Moreover, the extreme financialization of agricultural commodities has further complicated the task of market regulators and policy makers, leading to an ever increasing number of opaque transactions, the majority of which escape any kind of control.
As a result, since most transactions on the OTC market never involve investors buying or selling on the cash market, these transactions amount to purely financial speculation. For instance, Dirk Müller mentions the report issued by the Chicago Board Of Trade (CBOT) which states that 2.6 million futures and options contracts were traded in May 2011. With a single contract alone, about 136 tons of wheat were traded, resulting in a total trading volume of 356 million tons of wheat. By way of comparison, this trading volume is equivalent to 52 per cent of global wheat production in 2009.
This situation negatively impacts both agricultural activity and global food security. Markets are disconnected from reality, and are becoming ever more complex and anticipating, leading to high price volatility.
momagri Editorial Board
The extent of speculation
Until the turn of the century, there was very little speculation and financial investment in food; at best, very few specialized traders and financial analysts were active in this area. However, this has dramatically changed in recent years. During the period 2003-2008 alone, investment in the two biggest global commodity index funds shot up from $13 to $317 billion – a spectacular growth of 2,300 per cent.
Originally, commodity exchanges, at which for instance wheat futures contracts are traded, played a constructive role for “real” agriculture. Farmers were able to sell their production to the miller at the “future” price quoted on the commodity exchange well in advance of the harvesting date. In this way, both sides could better plan their business, because they knew at what price the product would be sold, and the farmers were no longer exposed to further price fluctuations. Thus commodity exchanges provided risk management, or rather risk reduction, services. Since about 1999, the international finance lobby persuaded regulators to relax or lift restrictions on commodity futures trading, which banks and investment fund managers viewed as a lucrative business. However, this eventually led to a perverse market situation. The fact that speculators at commodity exchanges only need to have a fraction of their contracts backed by proper (real) funds (the so-called margin) results in an artificial increase in investments through credit.
The Chicago Board of Trade (CBOT) Exchange Volume Report of May 2011, reported trading of some 2.6 million futures and options contracts in that month. With a single contract, about 136 tons of wheat (5,000 bushels at 27 kg) were traded, resulting in a total trading volume of 358 million tons of wheat (at a value of about $90 billion), and that at just one commodity exchange in Chicago. By way of comparison, this trading volume is equivalent to some 52 per cent of the total global wheat production of 2009.
Besides “formal” trading operations at commodity exchanges, many deals are made directly between financial market participants outside the official exchanges via telephone or via so-called “dark pools” (as over-the-counter (OTC) transactions). The supervisory authorities get very little information on the nature and volume of such deals. This is symptomatic and a contributory cause of the current financial crisis: since policymakers and regulators are not aware of the risk exposure and what consequences and domino effects the default of one market participant may have on the stability or fragility of the financial system, they do not have a solid information on the basis of which to make informed and reasonable decisions. This also applies to the commodity trading market.
According to the Bank for International Settlements (BIS), the total volume of OTC transactions in 2010 amounted to $601 trillion. This amount is equivalent to 10 times the size of the world’s GDP, estimated at around $60 trillion that year. The largest share of OTC transactions concerned interested-related deals, but commodity transactions were estimated to amount to about $3 trillion – almost the equivalent of Germany’s GDP.
Impact on commodity prices
Price volatility in certain commodity markets, including for some grains, has significantly increased, though it is very difficult to determine to what extent this is due to effect of escalating speculation on specific commodity prices. Whereas in the distant past prices varied only marginally, today a doubling of prices or a drop of 50 per cent or more is no longer a rare occurrence. This level of extreme volatility can hardly be explained by market fundamentals alone (…).
1 Read the full article and report by following this link http://unctad.org/en/PublicationsLibrary/ditcted2012d3_en.pdf