June 19, 2018

Speculation and Prices

As the market prices of some commodities have increased recently, issues associated with “market speculation” have arisen.

An academic report released this month by Dwight R. Sanders, Scott H. Irwin, and Robert P. Merrin, entitled, “The Adequacy of Speculation in Agricultural Futures Markets: Too Much of a Good Thing?” provided a more rigorous look at some of the variables surrounding this issue.

The Abstract of the paper stated that, “The objective of this report is to re-visit the ‘adequacy of speculation’ debate in agricultural futures markets. The Commodity Futures Trading Commission makes available the positions held by index funds and other large traders in their Commitment of Traders reports. The results suggest that after an initial surge from early 2004 through mid-2005, index fund positions have stabilized as a percent of total open interest. Traditional speculative measures do not show any material changes or shifts over the sample period. In most markets, the increase in long speculative positions was equaled or surpassed by an increase in short hedging. So, even after adjusting speculative indices for index fund positions, values are within the historical ranges reported in prior research. One implication is that long-only index funds may be beneficial in markets traditionally dominated by short hedging. Attempts to curb speculation through regulatory means should be weighed carefully against the potential benefits provided by this class of speculators.”

On page 14 of the report, the authors pointed out that, “The impact of speculators—especially index funds—on commodity prices is currently being hotly debated in the popular press and political circles (e.g., Masters, 2008). It is commonly asserted that speculative positions create a ‘bubble,’ where market prices far exceed fundamental values. Proposals have recently surfaced in the U.S. Congress to sharply increase futures margins in an effort to curb this damaging speculation (CHSGA, 2008). Indeed, recent political wrangling has spurred the CFTC to announce new initiatives for monitoring speculative traders in agricultural futures markets (CFTC, 2008b). When observing this debate, one is struck by the paucity of hard evidence typically used to justify positions, mostly negative, on the impact of speculation.”

On page 15, the report stated that, “There are additional reasons to be skeptical about the assertion that speculation has led to bubbles in agricultural futures prices over the last two years. First, the research presented in this report shows that the level of speculation in agricultural futures markets—as measured by Working’s T—is not outside of historical norms. If speculation is driving prices above fundamental values, it is not obvious in the level of speculation relative to hedging. Second, recent price increases do not neatly fit a bubble explanation. As shown in Figure 14, price increases are concentrated in the grain and oilseed markets. Yet, the highest concentration of long-only speculative positions is often in the livestock futures markets (Table 3), which generally did not participate in the price increases and for which index funds are rarely mentioned as problematic. It is difficult to rationalize why speculation by index funds would only impact particular agricultural futures markets. Third, very high prices have been observed for commodities without futures markets (e.g., durum wheat and edible beans) and in agricultural futures markets that are not included in popular commodity indices (e.g., rice and fluid milk). To assert that the commodity markets are being driven higher by a speculative bubble ignores historically low world grain inventories and other market fundamentals that are broadly driving commodity prices higher. Fourth, as Hamilton (2008) points out, if speculators create a bubble in futures prices for storable commodities, this also creates an incentive to store commodities because prices in the future exceed levels normally required to compensate inventory holders for storage. We should therefore observe an increase in inventories when a bubble is present. In fact, inventories for grains and oilseeds have fallen sharply over the last two years.”

Crop Issues, Food Prices

Associated Press writer Stevenson Jacobs reported yesterday that, “Raging Midwest floodwaters that swallowed crops and sent corn and soybean prices soaring are about to give consumers more grief at the grocery store.

“In the latest bout of food inflation, beef, pork, poultry and even eggs, cheese and milk are expected to get more expensive as livestock owners go out of business or are forced to slaughter more cattle, hogs, turkeys and chickens to cope with rocketing costs for corn-based animal feed.

“The floods engulfed an estimated 2 million or more acres of corn and soybean fields in Iowa, Indiana, Illinois and other key growing states, sending world grain prices skyward on fears of a substantially smaller corn crop. The government will give a partial idea of how many corn acres were lost before the end of the month, but experts say the trickle-down effect could be more dramatic later this year, affecting everything from Thanksgiving turkeys to Christmas hams.”

Susan Saulny reported in today’s New York Times that, “Total crop loss in Iowa — including hay and pasture — is most likely nearing $3 billion…[I]n Missouri, where floodwaters swallowed homes and agricultural fields north of St. Louis, the authorities said it was too early to determine the full scope of the flood’s destruction.”

Jerry Perkins reported in yesterday’s Des Moines Register that, “Soil erosion has caused substantial damage to Iowa’s farm fields hit hard by heavy rain and flooding this spring, Iowa Secretary of Agriculture Bill Northey said after touring two areas of the state.

“Heavy rains this spring came when the soil was most vulnerable to erosion – when the soil has been tilled for planting, but before plants’ root systems grow to hold it in place, he said.

“It isn’t known yet how much damage was done to soil conservation structures, Northey said, but he expects the state Legislature will need to provide a fresh infusion of money to repair the damage.”

Ethanol Impact

Meanwhile, Reuters news reported on Friday that, “U.S. ethanol distillers lost money on average during the week ending June 19 as flooding in the Midwest spiked prices for corn, the country’s main feedstock for the alternative motor fuel.

“Ethanol producers on average were losing a few cents for every gallon of ethanol they produced. ‘This has never happened before,’ Pavel Molchanov, an analyst at Raymond James and Associates in Houston, said about the negative profit margins that lasted through the week.

“Prolonged near-record corn prices would likely keep some producers from operating at full capacity, he said.”

The article stated that, “Molchanov said rising ethanol prices could be a ‘silver lining’ for the stronger ethanol producers, if prices rise enough to push margins back into the black.

“The ethanol crush spread fell about 13 cents to 30 cents per gallon, according to Reuters calculations. After conversion costs for making the fuel, including natural gas costs, ethanol producers were losing a few cents per gallon.”

More information on issues associated with ethanol production margins can be found here.

DTN writer Todd Neeley reported on Friday (link requires subscription) that, “The U.S. ethanol industry is in trouble and can expect to see a rash of bankruptcies and dismantling of at least some production, according to a specialist who helps companies in distress.

“Alex Moglia, president of Moglia Advisors based in the Chicago area, said he knows of at least 16 ethanol companies that are filing for bankruptcy, and there will be at least two to three times that number filing within the next year.

“Though he declined to give the names of companies involved, Moglia said, ‘There’s a whole host of them we’ve either looked at or handled.’

If Moglia is right, a U.S. ethanol industry shakeout that started last year is about to shift into high gear, potentially threatening the ability of the industry to meet mandates laid out in the Renewable Fuel Standard.”

Reuters writer Tom Doggett reported on Friday that, “Two U.S. House lawmakers introduced legislation this week that would lower the U.S. tariff on ethanol imports, boosting supplies of the fuel additive and hopefully lower gasoline prices for consumers.

“The bill would reduce the ethanol import tariff from 54 cents per gallon to 45 cents, bringing the tariff in line with U.S. ethanol blending subsidies, which a new farm law lowered to 45 cents per gallon from 51 cents.

“The measure’s sponsors, Democratic Reps. Mark Udall and Ed Perlmutter, both from Colorado, said the higher tariff would restrict supplies and increase the price of fuel.”

And Kenneth Rapoza reported in today’s Wall Street Journal that, “Floods in the Midwest are making coast-bound shipments of American corn ethanol nearly impossible, creating an opportunity for ethanol from Brazil.

“Demand might really jump if a 54-cents-per-gallon import tariff on Brazilian sugarcane ethanol is removed, which may spark another wave of investment in the South American nation. Two U.S. senators proposed such legislation this month as a way to lower ethanol prices in many parts of the country.”

The Journal article noted that, “Corn ethanol is selling in the U.S. for $2.80 a gallon, compared with about $1.87 per gallon for Brazilian ethanol, made from sugarcane. As corn prices have risen this year, Brazilian ethanol has become more competitive, despite the tariff.”

In a related article regarding ethanol trade, Bloomberg writer Carlos Caminada reported on Friday that, “The U.S., Brazil and the European Union are accelerating efforts to create global standards for ethanol and make the alternative fuel an internationally traded commodity, boosting its use, an American official said.

“Government and industry leaders discussing the plan may finish standardizing methods for analyzing ethanol properties such as water and energy content by December, four years ahead of schedule, the U.S. State Department’s Gregory Manuel said. Next, the group will begin to set content standards, he said.

“‘The U.S., Brazil and EU have agreed to fast-track the process,’ Manuel, Secretary of State Condoleezza Rice’s special adviser for alternative energy, said in an interview in Sao Paulo yesterday. ‘What we’ve achieved so far could have taken several years and we did it in several months.’

“The standards will let buyers and sellers worldwide trade ethanol like gasoline, oil, copper, sugar and other commodities, boosting the fuel’s use, Manuel said. Currently, a buyer in Sweden has to send engineers to mills in Brazil to test the fuel before buying it to sell to drivers of flex-fuel Saabs and Volvos in the Nordic country, he said.”

(For more on ethanol and the U.S. Presidential campaign, see, “Obama Camp Closely Linked With Ethanol,” by Larry Rohter, which was published in today’s New York Times.)

Land Values

Bloomberg writer Brian Louis reported on Sunday that, “Farmland is having its biggest revival in almost 30 years as the ethanol industry and Asian demand for corn and soybeans drive commodity prices to record highs.

“From Iowa to South Dakota to Wyoming, rural land prices have risen 78 percent to more than 200 percent over the past decade, according to farmers and data from Farm Credit Services of America.”

The article added that, “Last year alone, prices in Iowa increased 22 percent to a record $3,908 an acre, according to data compiled by Iowa State University Extension in Ames.”

Doha Review and Brazil Cotton Case Sanctions

An AFP article from yesterday reported that, “Brazil and other developing countries have complained that agriculture proposals at the World Trade Organisation do not open up markets enough, dimming prospects of a deal being reached this year.

“‘The options on the table do not seem to fulfil the mandate for substantial improvements in market access,’ the G20 group of developing countries said in a statement issued late Friday, referring to proposals on the farm sector.

“The G20 blamed developed countries, saying: ‘we have no indication of what those countries are prepared to do’ in terms of cutting subsidies.”

The article added that, “WTO Director General Pascal Lamy has repeatedly said a deal is ‘doable’ before the end of the year, but chances of any breakthrough look to be dwindling, with French President Nicolas Sarkozy being particularly unoptimistic.

“‘It would be highly unrealistic to keep wanting to negotiate a deal where we haven’t received anything on services, nothing on industry … and which would cut farm output by 20 percent while 800 million people are dying of hunger,’ Sarkozy said Friday.”

Reuters writer Laura MacInnis reported on Friday that, “The diplomat overseeing one of the most fractious areas of global free trade talks said on Friday he will leave his post in August, adding pressure on WTO member states to settle their differences before he goes.”

The article added that, “Don Stephenson, Canada’s ambassador to the WTO since 2004, has for the past two years mediated talks over cutting tariffs on industrial goods such as cars, shoes, fuel and timber.

“‘My term as Canadian ambassador ends in August,’ Stephenson told Reuters, saying his last official duty as industry chairman would be a report to the WTO’s 152-country membership ‘in the last few days of July.’”

According to the article, “Diplomats said Stephenson’s departure was an added incentive to resolve the industry issues in the next two months.”

In other WTO news, Reuters writer Laura MacInnis reported on Friday that, “Brazil said on Friday it would seek as much as $4 billion in sanctions on U.S. imports after the World Trade Organisation (WTO) adopted a final ruling in a long-running dispute over Washington’s cotton subsidies.

“Roberto Avezedo, Brazil’s chief trade negotiator, said his country would restart arbitration within months or even weeks to allow it to impose retaliatory measures on U.S. goods.

“‘We will. The only decision is when,’ he told journalists in Geneva. ‘We are holding internal consultations because the process will involve a number of legal points that have no precedence at the WTO.’”

The Reuters article pointed out that, “If granted, it would be the third time the WTO has authorised one of its 152 members to cross-retaliate, after Ecuador in 2000 in a banana dispute with the European Union, and Antigua in 2007 in an online gambling dispute with the United States.

“In its submission to a special session of the Dispute Settlement Body on Friday, the United States said the WTO findings in the cotton dispute were based on outdated evidence.

“‘The (WTO) compliance panel and appellate body reports deal with market conditions from two to three years ago. Since then, U.S. cotton acreage has fallen precipitously, and continues to decline,’ it said.

“‘Despite the allegedly marked-insulating effects of U.S. payments, U.S. cotton acreage has declined by more than 38.5 percent in the last two years,’ it added. Price-linked subsidies to farmers have also fallen as cotton prices have risen.”

Keith Good

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