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Market Speculation Drives Food Prices


Soaring global food prices have been blamed on factors ranging from biofuel production, rising energy costs and export curbs to supply and demand, tight commodity markets and investor speculation. While most experts agree that no one reason has caused the crisis, many blame speculation in commodity futures markets for inflating prices.

The price of rice and wheat has more than doubled in the past year. The price of corn, according to the World Bank, increased 55 percent in 2007, and soybeans were up 42 percent.

The United Nations says overall food prices jumped 45 percent in the past nine months, which means many developing countries could spend up to 60 percent of their income on food. Other commodities, such as metals and minerals have doubled or tripled in value in the past year.

All Commodities Are Not Alike

The U.S. all-commodities index, which lists commodities trading companies and the price of their stocks, has steadily grown in value in recent years, says David Lehman of the CME Group, a major commodities firm that formed after last year's merger of the Chicago Mercantile Exchange and the Chicago Board of Trade.

"On an index level, since mid-1999, the food commodity index has increased 98 percent. The index for all commodities has increased 286 percent and the index for crude oil has increased 547 percent. The all-commodities number includes base metals, precious metals. And the food commodities are grains, soft commodities," says Lehman. "So the price increase that seems so significant in the food commodities really has been quite tame compared to these other broader classifications."

Higher energy costs, growing demand and the use of agricultural land for biofuel production have contributed to the increase in commodity prices. Lehman says that has created lucrative opportunities in commodity futures markets for increasing numbers of investors.

"There is a growing use of commodity futures markets as an asset class. So investors who traditionally invest in stocks and bonds have recognized that the use of commodities diversifies the portfolio [i.e., in one's investments overall], reduces the overall risk level in the portfolio and, therefore, increases returns," says Lehman.

"A Safe Haven"

U.S. hedge funds, speculators and commercial and private investors have poured billions of dollars into commodity futures markets in recent years. This has made a huge impact on global markets, says economist Chad Hart of Iowa State University's Center for Agricultural and Rural Development.

"We do have a lot of investors seeking out not only agricultural commodities, but just all physical commodities in general as a safe haven for their funds to protect them against inflation and against the weak dollar," says Hart. "But just given the sheer volume of funds that we're talking about being pushed into some of these commodities, especially the agricultural commodities, just in terms of dollars, that creates a fairly sizeable impact on the markets they are entering."

While conceding that speculation has contributed to inflating commodity futures prices, analyst Chuck Pierson of Investor Commodity Services in Minnesota cautions that other factors are also at work.

"Most of the speculators are momentum investors. So as the prices go higher, they are inclined to enter the market and try to profit out of the increase in prices. But these prices have been driven up for a lot of other reasons than pure speculation. It [i.e., speculation] is contributing to the increased prices. But you have hedge funds in our market now from equity investors trying to hedge their portfolios against inflation," says Pierson. "And the regulatory people are looking into that -- for instance, the size of what they [i.e., investors] can enter into the markets with. Some of the hedge funds don't have limits on the number of contracts they can buy because they are classified as hedgers."

The Long-Term Outlook

The U.S. Commodity Futures Trading Commission recently looked at the impact of investor money flowing into agricultural commodities and found that higher futures prices generally are not the result of market manipulation.

Dean Baker, Co-Director of the Center for Economic and Policy Research in Washington, notes that the effect of speculation is limited, whereas higher energy costs and growing consumption are likely to last a long time.

"Whenever you see sharp price movements, part of that is speculation. But speculation will not in the long-term keep prices high. It only does that temporarily because there's only so much wheat or corn or whatever that someone can hold off the market. They eventually have to bring it there because, obviously, it is a perishable product," says Baker. "So I think that food prices will be in part reversed. But I don't think they will be totally reversed. And as long as you have good growth in China and India and other developing countries, demand will continue to increase. So that will put upward pressure on price."

Some analysts say higher commodity prices, while benefiting investors, are not necessarily a bad thing for developing economies. This market environment, argues David Lehman of the CME Group, spurs innovation and encourages small farmers to grow more and profitable crops.

"It is increasing yields on the existing land while bringing more land into production. So many of these investors are actually helping bring prices to a level that will encourage greater production and help ration some of the scarce supplies we have. Now that the returns to that investment in agricultural commodities are commensurate with returns in other areas, I have confidence that we will allocate more funding to research and investment in agriculture, that these high prices are exactly what's needed to stimulate increased production," says Lehman. "So the market will bring things back into balance."

In the meantime, food prices continue to soar to levels that many analysts say are beyond the reach of many of the world's poorest nations.

This story was first broadcast on the English news program, VOA News Now. For other Focus reports click here.

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