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Speculation in food commodity markets

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Market / Trade
Nutrition / Food Systems
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Risk assessment
Thomas Lines
World Development Movement

Numerous explanations have been given for the food price crisis. Soil quality is deteriorating, water is running short, some harvests have been poor and growing demand for meat increases the use of grains for animal feed. The increased rice yields of the Green Revolution are leveling out, while biofuels are taking up more and more agricultural land. All this has led world cereal stocks to decline in proportion to demand for several years. These reasons relate to what commodity traders call ‘the fundamentals’: the physical balance of supply and demand. But they do not explain everything. Consider these two comments:
‘At the source… was a supply phenomenon and a demand phenomenon, which was explaining most of what we have’ (Jean-Claude Trichet, President of the European Central Bank); ‘In 2006, the International Monetary Fund concluded that in commodities generally, speculative activity responded to price movements rather than the other way round. But by this March the IMF was puzzling over why prices were still rising in spite of the credit crunch and economic slowdown. A large part of the reason, it decided, was financial buying.’ (Financial Times, May 12th, 2008.)

There is no contradiction here. The fundamentals of supply and demand are indeed ‘at the source’ of price rises, as M. Trichet put it. But as a matter of course, speculative activity responds to such price movements,  as the IMF stated. A herd instinct animates financial investment and explains frenzies such as stock market and house price booms. On commodity markets too, a price surge entices speculation (‘financial buying’, in the FT’s phrase) to come in and amplify it, and even take it over.

In Asia traders hoarded rice: a speculative activity as ancient as agricultural trade itself. The financial form of hoarding is conducted further away but it is more powerful. Ever since the commodities boom began, financiers have been setting up funds to ‘invest’ in commodities. This is often done indirectly, for example by purchasing mining companies’ shares. Other funds trade on indices of the average prices of commodities. It was estimated that investments in such commodity index funds increased from US$46 billion in March 2005 to $250bn in March 2008.