Commodities Speculators

Gas prices are going up with no end in sight. Food prices are rising. We're obviously in an inflationary period and a recession. Wages aren't going up so we have stagflation plus a recession or to coin a term - recesstagflation. It's the worst of all economic worlds. The speculators and hedge fund managers, having profited from the stock market bubble of 2000 which later burst and the sub-prime mortgage bubble which is still bursting, have now turned their attention to the commodities market, driving up prices much as they did in the stock market and real estate. Originally the commodities market had a simple raison d'etre: payday advance for farmers. Farmers could sell their crop whether it be corn, wheat or pork bellies on the futures market before the crop was even in the ground or the animals had even been led to slaughter at a set price. The crop or animal part was to be delivered at a future date, thus the name - futures. Now in most cases the buyer of the futures contract had no intention of taking delivery. He or she was just a middle man or woman. They made their money by selling the contract to someone else for an even higher price than what they paid. Finally, the end user would buy the shipment of the actual product having paid more or less than what the farmer received in the first place. The same principles apply to the oil market.

Now just as in the mortgage market, the commodities market was deregulated making all kinds of financial chicanery possible without any government snooping or looking over their shoulders. This led to disastrous results in the mortgage market as we are seeing unfold in real time. The difference between the mortgage market and the commodities market is that homeowners who were not able to make their payments could default on their loans and walk away with their home going into foreclosure. Commodities speculators have a market for which the end product can not be walked away from. People have to eat no matter what.

So that brings us to the second key difference between the housing crisis and the food crisis: the scale of consequences. When a housing bubble inflates till it pops, people lose their homes. But when a food bubble grows till it bursts, people starve. The problem with booms is they're almost inevitably followed by busts. Worse news is that what we're seeing right now-skyrocketing food prices and growing hunger-are still the effects of the boom. If the weather turns bad, commodity prices could still double over the next few months. But with the stability of the food and agriculture system left up to the whims of mother nature's next crop yield, or how Cargill, ADM and the venture capitalists spin the roulette wheel, the bust is in the making. If the rural farm economy tanks, we're set to see farm foreclosures, another banking crisis, and global hunger that will make the sub-prime mortgage effects look like a drop in the bucket.

So as they pour money in, they know that the futures price will only go up, never down because there are always more mouths to feed, never fewer. Much as in the case of Enron jerking around the energy market, the speculators have latched onto something consumers will pay any price for: gas and food. So just as Enron caused the price of electricity to go sky high by manipulating the market, commodities speculators can trade futures contracts back and forth driving up the prices of gas and oil without pesky government intervention.

From the Washington Post:

Farmers and food executives appealed fruitlessly to federal officials yesterday for regulatory steps to limit speculative buying that is helping to drive food prices higher. Meanwhile, some Americans are stocking up on staples such as rice, flour and oil in anticipation of high prices and shortages spreading from overseas. Their pleas did not find a sympathetic audience at the Commodity Futures Trading Commission (CFTC), where regulators said high prices are mostly the result of soaring world demand for grains combined with high fuel prices and drought-induced shortages in many countries. The regulatory clash came amid evidence that a rash of headlines in recent weeks about food riots around the world has prompted some in the United States to stock up on staples. Costco and other grocery stores in California reported a run on rice, which has forced them to set limits on how many sacks of rice each customer can buy. Filipinos in Canada are scooping up all the rice they can find and shipping it to relatives in the Philippines, which is suffering a severe shortage that is leaving many people hungry. While farmers here and abroad generally are benefiting from the high prices, even they have been burned by a tidal wave of investors and speculators pouring into the futures markets for corn, wheat, rice and other commodities and who are driving up prices in a way that makes it difficult for farmers to run their businesses. "Something is wrong," said National Farmers Union President Tom Buis, adding that the CFTC's refusal to rein in speculators will force farmers and consumers to take their case to Congress. "It may warrant congressional intervention," he said. "The public is all too aware of the recent credit crisis on Wall Street. We don't want a lack of oversight and regulation to lead to a similar crisis in rural America." ... The upswing in prices has been exaggerated by the massive influx of investors and speculators seeking to profit from rising prices for corn, wheat, oil, gold and other commodities. Big Wall Street firms and hedge funds have taken huge positions in futures markets that once were dominated by relatively small operators such as farmers and grain-elevator owners. Small investors, who see fast-rising commodities as good hedges against inflation and a falling dollar, also are getting a piece of the action by investing in index funds that are tied to commodity prices.

Now the speculators know there are world wide food shortages so by the law of supply and demand and because of inflationary pressures on the American dollar, they are only going to make money by buying a fixed quantity of a commodity now and selling the contract before the delivery date to an end user. This drives up the price of the commodity whether it be food or oil because, unlike the housing market, people need to eat and drive. Now some people think this is creating another bubble. Exchange-traded funds and index funds allow speculators to place bets that commodities will go up or down in the future. Money has flooded into these funds mostly on the long side. In other words most people are betting that the prices of commodities will continue to go up, hence the bubble. The "smart money" is betting that at some time there will be a correction and prices will tumble. However, increased demand for meat (it takes 8 pounds of grain to produce one pound of meat) and ethanol means that less food is available to those in poorer countries who are dependent on the grains to avoid starvation. This has produced food riots in some parts of the world.

So just as speculation in the housing market drove up the cost of houses to unsustainable heights providing homeowners with gains in equity that caused them to think that they could refinance unendingly, pull equity out and spend it, money pouring into the commodities market is driving up the cost of gas and food, two essentials that are consumed immediately and thus have no inherent equity value. The homeowner profited by riding the mortgage bubble at least till it ended, but there is no profit for the consumer who must pay higher prices for staples driven by speculators and investors. And poor people are the most vulnerable to rising prices. But this may be the greatest boon to investors who may profit endlessly from rising demand on the backs of increasingly desperate poor people.

None of this speculation is really necessary. If the farmer needs a payday advance, why can't he get it from a commercial bank rather than Wall Street? I'm sure his equity in his farm would justify a loan. There's no need for a futures market in which the farmers themselves participate in order to get the highest price. All the financial middlemen are just driving up the cost of food and gas and ultimately will cause starvation among the world's poor. Let the farmer sell directly to the end user and finance his crops with a loan from a commercial bank if need be. This is just another example of capitalism run amok. The answer is not more regulation; it's making speculation illegal!

Comments

[Mr Zetetic]

A very well thought out piece. You have however missed one key component. Due to decades of economic abuse by American Congress, fraud by Wall Street financial houses, and excessive dilution by the Federal reserve, the US dollar is currently in the process of reverting to its true value which is the value of used paper.
The fact that there is a speculator demand for commodities is driven by the realisation that to hold your wealth in dollars is a losing prospect. The only thing that is worth holding are tangiable assets that can not be diluted by printing more at the stroke of a key.