Are Higher Commodity Prices driven by Speculation or Fundamentals?
by Larry Martin
"Introduction
It never fails.
Each time commodity prices rise there are calls for more curbs on speculation. A recent one in late July was Sylvain Charlebois, of the University of Guelph College of Management and Economics. But other “experts” have and will continue the drumbeat. They always do when shortages drive prices up.
Charlebois, in an article that appeared in a number of newspapers, asserts (with no evidence) that:
What is driving commodity prices upward is speculation; too much, that is. Speculation is obviously nothing new to markets. However, excessive speculation in derivative markets has enhanced the rate of price swings in recent years. Agriculture has recently attracted what many call “price manipulators” — hoarders and influential speculators who are attracted to commodities, as they are believed to move in an opposite direction to equity markets, thereby providing a hedge against inflation. As a result, regular traders are not able to hedge their risk, and farmers are not getting benefits of price rise, while manipulators cash in. Regrettably, therein lies the real story behind current soaring prices.
2 Commentary –
Is it true traders cannot hedge their risk and farmers cannot benefit?
The starting point for critiquing this is the sentence, “regular traders are not able to hedge their risk, and farmers are not getting benefits of price rise”. I work with real people with real hedging plans. I witnessed Canadian livestock feeders use the opportunity to buy corn futures around $6.00 per bushel and hedge against the run up to $8.00. Recently, with corn and soybeans at all-time highs and wheat and canola exceeded only by the 2008 highs, the grain farmers I’m dealing were trying to decide whether to price more of their product or whether the drought will take prices higher yet.
So, traders actually have not had a problem hedging their risk and farmers are able to get the benefit of the higher prices. Nothing is standing in the way of either outcome. There is no lack of liquidity in the market – a hedger can take a position anytime. There have been very few, if any, limit moves. In fact the new longer trading hours, including before and after US Department of Agriculture (USDA) reports, appear to have dampened the inclination for limit moves caused by surprising reports, thereby removing that hedging problem. Similarly, basis levels held up and some even firmed in this rally. So, there is no reason that hedgers can’t hedge and farmers can’t benefit from rising prices.
No question that some grain farmers contracted at lower prices in June and July, and a few sold more than they produced because of weather – reduced yields. But it’s difficult to blame that on speculators. In May, the USDA forecast a record yield of corn at 166 bushels per acre, with record acreage. Prices plunged to $5 and professional analysts were warning that corn prices could slump to $4.00 or lower.
Speculators certainly weren’t driving prices up then. Then it became obvious that much of the US was affected by drought. USDA lowered its July yield estimate to 144 bushels per acre. That’s a 13% drop in the corn crop, even before taking into account the fact that some of the acres will not be harvested at all. With about four weeks of corn use in inventory, a drop of more than 15% in the expected crop meant that price needed to rise to ration the product over the storage period. They rose again.
In August, USDA dropped its yield estimate by another 15% to 123.6 bushels per acre. If this is correct, the US will have the lowest inventory of corn relative to use in history. Usually when supply declines relative to demand, prices rise to ration the supply. Some farmers in Canada certainly did not anticipate the extent of the drought and did sell at what now seem to be low prices. They didn’t seem low at the time the decisions were made given the information available. And some didn’t anticipate how much the drought was going to affect their own crops. ..."
For the rest of the paper; Go To:
http://www.macdonaldlaurier.ca/files/pdf/Commentary-Commodity-Nov2012.pdf?utm_source=MLI Newsletter Vol. III%2c No. 6&utm_campaign=Newsletter November 2012&utm_medium=email
Larry Martin is a principal in Agri-Food Management Excellence Inc., a company that specializes in management training for the agri-food sector. He has taught courses on hedging with futures and options to over 1000 Canadians over the past 40 years. He authors a monthly column on commodities for Food in Canada Magazine and assists a number of Canadian businesses with their risk management programs.
by Larry Martin
"Introduction
It never fails.
Each time commodity prices rise there are calls for more curbs on speculation. A recent one in late July was Sylvain Charlebois, of the University of Guelph College of Management and Economics. But other “experts” have and will continue the drumbeat. They always do when shortages drive prices up.
Charlebois, in an article that appeared in a number of newspapers, asserts (with no evidence) that:
What is driving commodity prices upward is speculation; too much, that is. Speculation is obviously nothing new to markets. However, excessive speculation in derivative markets has enhanced the rate of price swings in recent years. Agriculture has recently attracted what many call “price manipulators” — hoarders and influential speculators who are attracted to commodities, as they are believed to move in an opposite direction to equity markets, thereby providing a hedge against inflation. As a result, regular traders are not able to hedge their risk, and farmers are not getting benefits of price rise, while manipulators cash in. Regrettably, therein lies the real story behind current soaring prices.
2 Commentary –
Is it true traders cannot hedge their risk and farmers cannot benefit?
The starting point for critiquing this is the sentence, “regular traders are not able to hedge their risk, and farmers are not getting benefits of price rise”. I work with real people with real hedging plans. I witnessed Canadian livestock feeders use the opportunity to buy corn futures around $6.00 per bushel and hedge against the run up to $8.00. Recently, with corn and soybeans at all-time highs and wheat and canola exceeded only by the 2008 highs, the grain farmers I’m dealing were trying to decide whether to price more of their product or whether the drought will take prices higher yet.
So, traders actually have not had a problem hedging their risk and farmers are able to get the benefit of the higher prices. Nothing is standing in the way of either outcome. There is no lack of liquidity in the market – a hedger can take a position anytime. There have been very few, if any, limit moves. In fact the new longer trading hours, including before and after US Department of Agriculture (USDA) reports, appear to have dampened the inclination for limit moves caused by surprising reports, thereby removing that hedging problem. Similarly, basis levels held up and some even firmed in this rally. So, there is no reason that hedgers can’t hedge and farmers can’t benefit from rising prices.
No question that some grain farmers contracted at lower prices in June and July, and a few sold more than they produced because of weather – reduced yields. But it’s difficult to blame that on speculators. In May, the USDA forecast a record yield of corn at 166 bushels per acre, with record acreage. Prices plunged to $5 and professional analysts were warning that corn prices could slump to $4.00 or lower.
Speculators certainly weren’t driving prices up then. Then it became obvious that much of the US was affected by drought. USDA lowered its July yield estimate to 144 bushels per acre. That’s a 13% drop in the corn crop, even before taking into account the fact that some of the acres will not be harvested at all. With about four weeks of corn use in inventory, a drop of more than 15% in the expected crop meant that price needed to rise to ration the product over the storage period. They rose again.
In August, USDA dropped its yield estimate by another 15% to 123.6 bushels per acre. If this is correct, the US will have the lowest inventory of corn relative to use in history. Usually when supply declines relative to demand, prices rise to ration the supply. Some farmers in Canada certainly did not anticipate the extent of the drought and did sell at what now seem to be low prices. They didn’t seem low at the time the decisions were made given the information available. And some didn’t anticipate how much the drought was going to affect their own crops. ..."
For the rest of the paper; Go To:
http://www.macdonaldlaurier.ca/files/pdf/Commentary-Commodity-Nov2012.pdf?utm_source=MLI Newsletter Vol. III%2c No. 6&utm_campaign=Newsletter November 2012&utm_medium=email
Larry Martin is a principal in Agri-Food Management Excellence Inc., a company that specializes in management training for the agri-food sector. He has taught courses on hedging with futures and options to over 1000 Canadians over the past 40 years. He authors a monthly column on commodities for Food in Canada Magazine and assists a number of Canadian businesses with their risk management programs.
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