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They’re Baaack: Speculators Return to Grain Markets En Masse

September 1, 2010


You may not have noticed, but hedge and index fund investors have quietly returned to the agricultural commodities market in droves over the past few weeks. With the stock market continuing to flounder, these speculators are positioning themselves for another bull run on agricultural commodities and crossing their fingers that corn prices go higher. They've laid down their bets that the drought in Russia and flood-induced crop failures in Pakistan will leave the world short of grain and spur demand and prices for U.S. grains. As clearly demonstrated by the 2008 commodities bubble, supply-demand fundamentals take a back seat to frenzied speculation when this many trigger-happy gamblers are in the market. Don't be surprised if even the slightest hints of higher demand for U.S. crops or lower-than-expected U.S. supply touches off speculative hysterics not seen since the spring and summer 2008. If a speculative rally on corn does come to pass this fall, let's at least hope that the pundits recognize the role of speculators and avoid immediately jumping to the conclusion—as they did in 2008—that biofuels had anything to do with it. According to a Bloomberg article last week, "Speculators including hedge funds are more bullish on commodity prices than at any time since April 2008 after adding wagers that wheat and corn will keep climbing..." April 2008 was, of course, the prelude to the most spectacular meltdown of the U.S. commodities markets in history. Crude oil futures prices skyrocketed from around $70/barrel in the early fall of 2007 to $90/barrel by early February 2008. Crude prices blasted through $100/barrel in April en route to a record $145/barrel on July 11, 2008.  Other commodities—including corn, wheat and soybeans—were pulled along for what proved to be a very wild and unpredictable ride. Corn prices jumped from around $4/bushel in December 2007 to $5 in February 2008 to a record of $7.88 on June 26, 2008. Wheat and soybeans also spiked to record highs. According to Barron's, the enormous commodity price bubble "lift[ed] prices far above fair value." But like any bubble, the commodities monstrosity of 2008 had to pop. And, boy, did it pop. By mid-December, prices for oil had tumbled to under $40/barrel, corn fell to about $3.50/bushel and other commodities similarly collapsed. In the wake of the bursting of the 2008 commodities bubble, there was much hand-wringing, head scratching and finger-pointing. What had caused the disaster? Who was responsible? What should be done to ensure it doesn't happen again? While some misguided critics attempted to vilify biofuels as a primary cause of the commodity rollercoaster, clearer heads argued that speculative investors—particularly hedge funds and so-called index funds—likely played  the most significant role in inflating the 2008 commodities bubble to historic proportions. There were hearings and investigations about the role of speculative investors in the whole debacle. There were reports and studies. Tighter oversight was promised and there were pledges made that gross manipulations of the commodities markets would not and could not be allowed to happen again. But has anything really changed since the summer of 2008? As far as grain markets are concerned, it certainly doesn't appear so. Speculators are returning to the agricultural commodities markets in numbers not seen since the weeks leading up to the spectacular bursting of the 2008 bubble. In fact, the Commodity Futures Trading Commission's (CFTC) latest Commitments of Traders report shows speculative investors hold as many corn futures contracts today as they did at the height of the 2008 bubble. Not since May 2008 have "non-commercial" investors (CFTC's parlance for "speculators") held as many net long positions as they do today (long, or "bullish," positions are contracts that are purchased and held in the hope of profiting from an increase in prices). Speculators held 358,000 net long positions on corn last week, which is the equivalent of 1.8 billion bushels. That compares to a previous high of 360,000 net longs in mid-May 2008, at the height of the bubble. Swap dealers, whom CFTC does not include in its non-commercial category (because it can't easily be determined if their counterparties are commercial traders or speculators), last week held another 402,000 net long positions —or the equivalent of 2 billion bushels. So, the total number of bullish contracts held by speculators and swap dealers is equivalent to an amount of corn that would produce more than 10.5 billion gallons of ethanol (which is essentially what the industry produced in 2009). Speculative investors will never see a single kernel of the corn they own on paper. They have no intent whatsoever of ever taking delivery of the grain (can you imagine a railcar of corn being unloaded in the middle of Wall Street?!). Their goal is simple: buy low, fan the speculative flames that increase prices, sell high and rake in the profits. It's a formula that made a lot of money in 2007-2008 for a lot of people who had never set foot in a corn field. Over the years, we've often disagreed with Joachim von Braun, former director general of the International Food Policy Research Institute (IFPRI), about the true impacts of biofuels on world food markets. He has maintained that biofuels played a principal role in the commodity bubble of 2008; we believe objective data and analysis prove otherwise and that biofuels have been vindicated. But one area where we have routinely agreed with von Braun is that unbridled speculation in agricultural markets is clearly a recipe for disaster. In an essay published just a few weeks ago in Financial Times, von Braun argued that "Some lessons have been learned from 2008, but too little has been done to prevent future crises." Von Braun also advocates increased regulatory oversight of commodities markets to mitigate the price distorting effects of excess speculation: "While the financial markets have recently been regulated to curb excessive speculation, commodity markets have remained largely untouched and are the open flank of the system attracting speculation." It's interesting that von Braun's Financial Times piece doesn't mention the word "biofuels" once—maybe hindsight and better analysis have softened his stance on the real impacts of biofuels on global grain markets. Other critics who initially believed biofuels played a role in the 2008 commodity bubble have since recanted and determined that speculative investment was a much larger factor. A hastily written working paper by World Bank that was never released (but "leaked" to the press in 2008) suggested biofuels growth was the predominant factor in the 2008 commodity bubble. But just one month ago, the World Bank released another paper that reversed that conclusion. The new paper concluded, "We conjecture that index fund activity (one type of "speculative" activity among the many that the literature refers to) played a key role during the 2008 price spike. Biofuels played some role too, but much less than initially thought." Hopefully we learned a few lessons from the speculation-fueled commodity bubble of 2008. Let's hope lawmakers, regulators, and market actors can come together to develop practical measures that limit the market distorting impacts of excessive speculation. And let's hope the rapid influx of speculative investors into the corn market over the past few weeks doesn't result in fundamentals giving way to frenzy.