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A Flock of Speculation: How Paper Bushels, Not Ethanol, are Driving Corn Prices

March 16, 2011


Last year, the World Bank noted in a study on the run up in food prices in 2008 that, "...the use of commodities by financial investors may have been partly responsible for the 2007-08 spike."  That is to say, speculation and not fundamentals of supply and demand drove prices higher during that spike.  The exact same phenomenon is playing out again in 2011. If you needed any more proof that large speculative investors are toying with the agricultural commodities markets and causing wild volatility, you need look no further than the erratic behavior of the corn market over the past two weeks. Corn futures prices have tumbled by $1/bushel just since March 3, as huge index and hedge funds and other large speculators are pulling out of the market as fast as they jumped into it last fall. As Matt Maloney, a broker with R.J. O'Brien & Associates, says of the liquidation, "It's just going to get worse." While biofuel opponents have garishly attempted to blame ethanol for the recent run-up in corn prices, the speculative gyrations in the marketplace over the past several months underscore once again that the market is being driven by the whims of non-commercial investors who will never see a kernel of the corn they bet on from their Wall Street offices – so-called paper bushels. So, why are speculators rushing for the exits? The theory is that Japan, the world's largest importer of U.S. corn, will dramatically cut back its shipments because major ports were damaged and demand has essentially frozen amidst the turmoil resulting from the earthquake and tsunami. But is it logical that the situation in Japan would curtail corn demand enough to knock $1 off of corn prices (about 14%) in a week's time, especially when other demand underpinnings haven't changed? Japan typically imports some 600 million bushels of corn from the U.S. Assuming that the current situation might reduce annual Japanese corn import demand by 10%, or even 25%, we're talking about a 60-125 million bushel reduction in demand—that's less than 1% of projected total use of the 2010 U.S. corn crop. Indeed, James Riley with the Linn Group wrote last Friday, "I don't know if you can blame the sell-off in grains on the earthquake, but that is what will be portrayed today." The point is this: the market is extremely (and unnecessarily) jittery and volatile because any event that has even the slightest potential implications for corn use often triggers massive over-reaction by speculators. And they move like a flock of sheep; if the bellwether finds a hole in the woven wire, the rest of the flock is sure to quickly follow for fear of getting left behind. Back in early September, as corn prices rose above $4.50/bushel, we warned that speculators were rapidly returning to the grain futures markets in droves and that things were likely to get hairy as a result. By mid-December, as huge funds continued to pour money into corn futures, prices for nearby futures jumped to well over $6/bushel and eventually closed near $7.40/bushel on March 3. Yesterday, as speculators continued to jump ship, May corn closed at $6.36/bushel. As we learned all too well during the bursting of the great commodity bubble in 2008, prices can collapse in a heartbeat and the market is left in shambles. It seems highly unlikely that a similar meltdown would happen this time around, but the impulses of the speculators who run roughshod over these markets are totally unpredictable. As long as uninformed (and/or untruthful) critics continue to finger ethanol as a leading cause for high corn prices and increased volatility, a root cause of the problem—excessive and unrestrained speculation in commodities—will persist and only get worse. Let's focus on the real problem behind artificially high prices and volatility, rather than the red herring of "food versus fuel."