Is it boom or bust time for commodities?

21st August 2012

And US hamburger chain Wendy's is battening down the hatches, preparing for a four per cent rise across its major food commodities – the beef and the burger buns – over the next year.

It's just one of tens of thousands of food firms across the world from global groups to local restaurants which are suffering from the huge jump in the price of grain used both to make bread and to feed cattle. Wendy's plans to save costs by "streamlining the supply chain" – others either have similar solutions or will pass on the extra to consumers.

The background to the surge in corn, wheat, soya bean and other food commodity prices is controversial.

One camp claims that the record levels are down to speculation. It believes that as investors, including hedge funds, private equity houses and exchange traded funds, see prices rising, they exacerbate the process with their money following the money that is already there, forcing prices ever higher.  Corn and soya bean have increased 10 and 20 per cent respectively since this time last year. This can all lead to potential poverty and starvation – this Mindful Money post has more.

Chicago comes to London

The 'anti-markets group' cites the proposed entry of Chicago commodity exchange CME  into the London market as proof that financial forces have overwhelming impact on the cost of food, hitting those in poor countries or the disadvantaged in better off nations the hardest. CME failed earlier in 2012 to buy the London Metal Exchange. However, CME says that while it hopes to have the regulatory permissions needed to open next year, it will only trade currencies not corn or coffee. But those opposed to speculation say this is merely a first move, showing a renewed confidence in commodities as an asset class and that the world's biggest food trading platform in Chicago will not miss out on opportunities further ahead – in any case, higher trading activity in soft commodities will bring added volume to currency dealing as most farm products are denominated in dollars.

Their opponents, primarily from the world of agricultural commodity trading, say their activities and their markets are neutral.  They believe food prices are rising due to shortages caused by record high temperatures and drought in the key US grain producing areas coupled with record rain and low temperatures in much of Europe. At the same time, the longer term factors of growing populations and an increasing appetite for meat  – cattle are far more corn intensive than a vegetarian diet, perhaps by a ratio of at least five kilos of corn to one of beef, or even a poultry based food pattern – has put pressure on prices as the world's farmers struggle to cope.

This group says the proof is the doubling in hay prices over the past year, following a period of more moderate growth around 8 per cent, when hay is not traded on commodity futures markets. The US faces its smallest hay harvest in over 35 years. Those who believe that speculation is to blame say that the hay price is dependent on other feeds -it's a substitute-  just as supermarkets will increase pasta prices if there is a shortage of potatoes.

Killing cattle to stay afloat

The result of high feed prices is that farmers slaughter cattle to save money. In the developed world, this means an immediate glut followed by a shortage. In the developing world, it can mean starvation as cattle provide far more than just meat.

Proponents of commodity trading say there was a well publicised surge in 2007-08 followed by a slump as farmers made the effort to grow more food and climates became more benign. Their view is that the upswing gets media coverage while the downturn is largely ignored.  They also draw a distinction between the trading of physical commodities and the futures and other derivatives based on them – something that the anti-speculator camp largely ignores, believing that there is a strong link between physicals and futures which cannot be undone.

Europeans want no future for futures

In Europe, according to the Financial Times , the criticism that investors could or would profit from rising food prices – to the detriment of the less well off – has resulted in a number of banks withdrawing or reducing their exposure to the agricultural sector.  It cites Austrian bank Volksbanken  saying it would pull out of investments linked to farm prices following criticisms from politicians while Commerzbank in Germany had already removed agricultural ETFs from its platform. Earlier this year, Germany's Deutsche Bank placed a moratorium on launching new ETFs based on food basics to give it time to examine whether links exist between markets and rising prices.

The World Development Movement wants curbs on food commodity speculation, appealing to supporters to write to George Osborne over food price issues. And in July, Finance Watch, a Brussels based public advocacy organisation, created a short online presentation  on commodity speculation. It did not condemn all market activity but complains "that in less than 10 years, the proportion of speculative activity in this market has jumped from 30% to more than 70%. This has changed the dynamics of the market, with consequences for producers, wholesale buyers and consumers alike."


More on Mindful Money

The real cost of rising food prices

Resource riches and commodity curses

The threat of food inflation

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