Abstract
Over the past decade, agricultural commodity prices underwent wild swings. Periods of high growth, 2008, were followed by periods of sudden decrease, 2009. The excessive increase in food price volatility is a subject of great interest because it has to do with the survival of mankind. Recent academic studies and policy makers have reached sharply different conclusions about the dynamics of such fluctuations. Also, some of them have indicated the main cause in speculative transactions and in the little regulation of futures markets. Then, this paper analyzes whether agricultural prices increases are due to increased speculative activity, otherwise to factors relating specifically to the commodities markets. The results of this preliminary analysis do not show a direct relationship between the increase in speculative transactions and spot prices, rather a more developed future market can be of benefit also to spot prices, as argued in many academic studies. Further statistical analyses tend to corroborate these conclusions. In fact, the first results of cointegration analysis show that there is no evidence that financial derivative instruments determine the fluctuation of wheat future price.
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Notes
- 1.
In the financial sector, in the common language, speculation suggest “a commercial transaction that seeks to earn a profit on the difference between current and future prices”.
- 2.
The index funds are funds that replicate the movements of specific market indices. The objective of this financial instruments is triple: the purpose of these financial instruments is to optimize the risk-performance ratio, to maintain a low correlation with traditional investment and to obtain positive returns, regardless of market trends through activities unrelated to original investment. In the raw materials field, these funds hold a certain number of differently weighted raw materials. During the purchase or sell of units, it is important to best represent the index. Generally, fundamentals are ignored. Index funds can exert pressure on agricultural market prices in different ways, often, although, agricultural commodities do not constitute most of these tools. In fact, when raising the price of non-agricultural raw materials, for example oil, the managers need to purchase agricultural products so that the balance between the different units is fair again. This strengthens the link between the different investment categories. In summary, a commodity index fund is a financial asset that invests on different futures or swaps markets with the aim of replicating profits in a price index.
- 3.
M. W. Masters, hedge funds manager and Masters Capital Management LLC founder, in May 2008, suggests that the determinant of increases—in 5 years—is to be identified in Corporate and Government Pension Funds and in other institutional investors, that he defines as a whole ‘Index Speculator’. These speculators ‘buy futures and then roll their position by buying calendar spreads. They never sell’. In this way, they consume liquidity and do not provide benefits to the futures markets. Regarding the correlation between their agricultural derivatives market entrance and periods of sudden price increases, Masters specifies that, after the severe equity bear market of 2002, this investors category began to look to the commodity futures market, pouring a liquidity on the main agricultural futures indices, speculating upward. Their strategy has meant that ‘assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008’, and the prices of the index commodities ‘have risen by an average of 183% in those five years’. In Masters opinion, commodity futures prices are the benchmark for the prices of actual physical commodities, so when Index Speculators, with their actions, ‘drive futures prices higher, the effects are felt immediately in spot prices and in the real economy’. Therefore, Masters is asking US Congressional intervention to restrict these operations.
- 4.
E.g. when the funds are used as a hedge in dollar fluctuations.
- 5.
The regression model Ordinary Least Squares aims to minimize the sum of residues, i.e. the difference between the observed and the estimated value, to the square.
- 6.
Although the origin of derivatives instruments dates back centuries, the birth and the strong developments of financial derivatives can be traced back to the beginning of the seventies of the last century with the introduction of currencies futures which followed, in subsequent decades, the derivatives on interest rates, on stock markets and on credit institutions.
- 7.
In him An essay on the principle of population and other writings of 1798, Malthus claimed that mankind had a destiny to hardships and misery if humanity itself does not put a brake on demographic growth. By examining some statistical data, he concluded that population growth was much greater than the ability to produce livelihoods. The fist was increasing, every 25 years, following a geometric progression, while food resources increased more slowly following arithmetic progression. In the face of such imbalance, caused by an excess of population, famines, epidemics and wars were unavoidable events. He called them as a ‘positive brakes’ because, rising considerably the mortality rate, made food resources again sufficient for the remaining population.
- 8.
For example, Argentina’s policy to eliminate grain export duties.
- 9.
‘Any trade restriction might harm the match of world supply and world demand and so provoke large price swings. The degree of market internationalization can be measured by the ratio of total world export divided by total world production (in volume). The degree of competition in a given market can also impinge on commodity price movements. Trade restrictions of a given country have a real effect only in case of strong market power’ (Geman 2015).
- 10.
Russia and Ukraine are among the largest producers and exporters of wheat.
- 11.
- 12.
- 13.
In the theory of speculative storage price dynamics is determined by ‘optimal’ reactions of agents—farmers and those who carry out the storage—who use all available information to generate rational expectations and take excellent positions for purchase and sale of goods. Under assumption of such behavior storage has a stabilizing effect, and the continuing price fluctuations are caused only by repeated random shocks. As Deaton and Laroque (1996) show, in the absence of storage, the prices are a linear fraction of individual shocks: ‘The presence of risk-neutral and profit-maximizing stockholders means that expected future prices cannot be greater than current prices by more than the cost of holding inventories into the future, so that, whenever stocks are held from one period to the next, prices in those periods are tied together. As a result, the actions of speculators will generate serial dependence in prices even when there is no dependence in the original shocks, and more generally, speculation will modify the serial dependence that would otherwise come directly from serial dependence in supply and demand. Speculative storage also changes the variability of prices; when speculators hold stocks and their expectation of the future price is sufficiently low, their sales will moderate the effect on price of negative supply (positive demand) shocks.’ In the absence of storage, prices would be too low, storage increase them and the sale of stocks, when prices are high, moderates the rise. Then, prices tend to be more stable.
- 14.
States that cannot safe and economic access to food for their populations are much more likely to face protests and suffer political instability. For some, the Arab Spring, which began in 2011, is an excellent example of all this. For the Arab word, in fact, the food price was an important reason for the 2011 protests.
- 15.
For example, the international tensions concerning water between India and Pakistan.
- 16.
Source CFTC.
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Manelli, A., Branciari, S., Montanini, L., D’Andrea, A. (2019). Sustainability of Real and Financial Markets. In: Longhi, S., et al. The First Outstanding 50 Years of “Università Politecnica delle Marche”. Springer, Cham. https://doi.org/10.1007/978-3-030-33879-4_11
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