Field of cornTim Boyle
The prices of agricultural commodities soared during 2007 and 2008, triggering riots and worries about food shortages, but the bubble-like rise wasn't caused by financial speculation in commodity futures markets, contends a study prepared for the Paris-based Organization for Economic Co-operation and Development.
The study, by two U.S. university economists, is likely to intensify the debate about regulatory reforms in the U.S. to limit the size of positions that individual speculators can take in futures markets.
Regulators are mulling over tighter controls because of worries that the huge flow of money into index funds that buy commodities contributed to the staggering run up in prices of everything from corn to crude oil before the financial crisis hit in 2008.
But the study found that the billions of dollars that investors placed into long-only commodity index funds wasn't accompanied by increased market volatility. They also found that prices rose in commodity futures that didn't receive index fund investments, such as rice, as well as commodities in that don't trade on a futures market at all, such as edible beans and apples.
These factors suggest that the rapid run up in agricultural commodity prices was influenced by strong, underlying consumer demand for the products in the economy, rather than by speculators.
"There is no smoking gun of a direct statistical link between the market participation of index funds and commodity futures price movements," said Scott Irwin, a professor at the University of Illinois, and one of the authors of the study.
The OECD said the findings indicate that regulators should tread cautiously when it comes to changing rules governing futures. One worry at the OECD is that that restrictions on the number of futures contracts funds are allowed to hold could reduce liquidity in the market, making it harder for farmers and other players in the agricultural business to hedge risks.
But the study was dismissed by some market participants who say it is implausible that the money poured into commodity linked index funds - by some estimates up to $200-billion (U.S.), had no impact on prices.
"I think the study ... is not reflective of market reality," said Michael Masters, a portfolio manager at Masters Capital Management who contends that the price bubble in oil , soybeans , corn and other commodities in 2008 was caused by commodity speculation by institutional investors.
Commodity futures allow producers, such as farmers, or companies using commodities, to hedge some of their financial risks by locking in fixed prices for their materials through contracts which expire at a later date, hence the futures moniker. Speculators pick up the other side of these contracts, hoping to make money from any swings.
Recently, however, index funds have become involved in this market, giving institutions and other mainstream investors easy exposure to commodities. The study said index investments increased to nearly $200-billion (U.S.) at the end of 2007 from $90-billion at the beginning of 2006, citing financial industry figures.
At the same time the funds were buying, commodity prices took off, with the Commodity Research Bureau index surging by 71 per cent from early 2006 to June, 2008, leading to concerns the two trends were linked. When the economic downturn hit in 2008, commodity prices wilted, but the controversy over the role of index funds has continued.
Earlier this year, the U.S. Commodity Futures Trading Commission proposed limits on the number of positions traders can hold on contracts for oil, natural gas and other energy-related futures, based on worries that speculative inflows of money distort prices.