Is speculation good or bad? A simple question that generates strident arguments. While this debate peaked last summer, a recent International Food Policy Research Institute (IFPRI) paper by Robles, Torero and von Braun1 examines a more pertinent question, ‘When does speculation really matter?’ The answer lies in looking into the specific conditions prevailing in the relevant market. Last year, as food prices soared into the stratosphere, countries went ballistic trying to protect their people. The root cause lay in a shortage in global cereal production due to drought. Coupled with the demand for bio-fuels as crude prices crossed unimaginable levels, this brought out a slew of price controls, export bans and defaults by food aid donors as reserves dwindled, adding stress on the grain markets. Some governments, including India, banned grain futures trading, drawing sharp criticism from many agricultural experts. Now with oil and food prices down from their 2008 highs, all the furore has died down. This is a good time to reflect on the true role of speculation in grain markets. The truth is that both markets, food and crude oil, remain delicately poised and another rupture is quite probable. Are we going to ban forward trading again or have we learnt something from last year?
The IFPRI paper analyses the role of financial speculation in the behaviour of agricultural prices from 2002 till 2008. Data from the Chicago Board of Trade shows a distinct rise in speculative activity in the grain futures market. They use the US Commodity Futures Trading Commission’s definitions to distinguish between commercial and non-commercial positions — the former is held for hedging purposes while the latter denotes speculative activity in search of financial profits. The ratio of long non-commercial positions to total long positions has grown over the years in the sample. There has also been a rise in the net positions held by index traders, indicating growing speculative activity, especially in the wheat market from 2006 to 2008. However, when the authors run statistical tests to check for the influence of this activity on the rise in prices, the evidence is not conclusive; results differed for time and crop samples. Though they conclude that speculative activities ‘might have been influential’, this is a call for concern for the simple reason that speculation in grain markets can result in ‘unreasonable or unwarranted price fluctuations’ that harm the poor and cause irreversible nutritional damage to children in developing nations.
Regulation of forward markets is a possible solution— making delivery on contracts or portions of contracts compulsory, limiting volume of speculation versus hedging, imposing capital deposit requirements etc. But they say, ‘Difficulties could arise, in walking the line between ineffective regulators (like the US Commodity Futures Trading Commission) and overzealous ones (like those in China and India).’ They, therefore, prefer another way out — creating a virtual reserve, a coordinated commitment by member countries — the G8 and major grain exporters — to contribute funds to stabilise grain markets when necessary. The presence of such a fund would work as a powerful signal preventing excessive price spikes.
While international grain prices have now crashed, last year’s shocks still reverberate. FAO reports higher domestic food prices than a year ago in 78 per cent of the cases studied in developing countries. One reason is the slow pace of imports, due to high prices during the marketing year and low reserves leading to less generous exporters and donors. Countries are also desperately sourcing farmland in Africa, India is just one small player in this land grab, and this leads to another set of geo-political issues. The crux of the problem? Food security and price volatility, issues which are here to stay. This was the agenda for the first ever G8 Agricultural Ministers’ Meeting in Italy last month. One of their recommendations is a monitoring and analysis of factors potentially affecting commodity markets, including speculation. So in the end, speculation in grain markets is not an evil thing, but in this tinderbox, it has the potential to provide a spark. Food price spikes hurt, and though it sounds a cliché, in the interconnected world we live in today, without global coordination in managing regulation and reserves, there can be no lasting resolution to the food crisis.
The author is chief economist at Indicus Analytics firstname.lastname@example.org
1 When Speculation Matters, IFPRI Policy Brief No. 57, February 2009, http://www.ifpri.org/PUBS/ib/ib57.asp