Commodity Futures Trading Is Up.
Since 2008, one indication of higher price volatility has been the significant increase in the volume of agricultural commodity futures traded on the Chicago Board of Trade (CBOT), a leading agricultural futures exchange. From 2005 to 2006, the average monthly volume of futures for wheat and maize grew by more than 60 percent, while the volume for rice futures rose by 40 percent. In 2007, traded volumes again rose significantly for wheat, maize, rice, and soybeans – especially soybeans, whose monthly average was 40 percent higher than in 2006 (see figure below).
In all commodities, volumes continued to increase during 2010–11. Moreover, open interest has also been growing in recent years, a trend that may reflect the entry of medium- and long-term speculators into commodity futures markets (see figure on the bottom of page 27). Such speculation may have played a role in the 2007–08 food price crisis (Robles, Torero, and von Braun 2009; Welthungerhilfe 2011).
Speculators normally make short-term investments; as they swarm into a market, they exacerbate the initial increase in price, and when they flee a market, they contribute to a fall in prices. In addition, agricultural commodities (including food products) have recently attracted more investment. They are regarded as a store of wealth that can protect against inflation or deflation of monetary assets, a characteristic that could explain the significant influx of money into index funds that include food commodities. Investment in such funds increased from US$13 billion to US$260 billion between the end of 2003 and March 2008, pushing up the prices of those commodities.
Today’s agricultural markets have three key characteristics that increase price responses to the biofuels, climate change, and commodity trading challenges.
First, export markets for all staple commodities – rice, maize, wheat, and soybeans – are highly concentrated in a few countries or very thin (that is, only a small share of production is traded). In the case of both maize and rice, the top five producers account for more than 70 percent of global production, and the top five exporters account for about 80 percent of world exports (see figure right). For wheat, the top five producers and exporters account for about 50 and 60 percent of global production and exports, respectively.
The United States is by far the largest global supplier of maize, wheat, and paddy rice, as well as the fourth-largest supplier of broken rice. Argentina and France are also among the top suppliers of maize and wheat, and Brazil is among the top producers of maize and rice. China is the largest producer of wheat and paddy rice, as well as the second-largest producer of maize; however, its production is locally oriented. These high levels of concentration imply that the world’s capacity for coping with geographical risk is limited. Any weather shock or exogenous shock to production in these countries will immediately have an effect on global prices and price volatility.
Second, the world’s reserves for maize and restricted reserves for wheat are now at historically low levels (see figure right). To function effectively, the market requires a minimum level of grain reserves to serve as a buffer against sudden changes in supply or demand. These reserves are needed because, in the short term, supply and demand for grain are not very responsive to price. When prices go up, for example, it is difficult for farmers to immediately produce more or for consumers to immediately consume less. As a result, any supply shock, such as a drought or flood, can lead to price spikes and hoarding by farmers seeking to take advantage of higher prices in the future. In both 1973 and 2007 global grain stocks hit record lows, prompting global food crises. Although the difference between too few grain stocks and just enough is relatively small, a lack of sufficient stocks can lead to large price increases and a breakdown of functioning markets. In 2007–08, grain stocks were only about 60 million tons (2.7 percent of global production) less than in 2004–05. But with prices rising sharply in 2007–08, this difference in grain stocks was enough to cause serious problems in the market, especially for commodities such as rice, the production of which is concentrated in just a few countries (Timmer 2010).
Third, appropriate, timely information on food production, stock levels, and price forecasting is lacking. When this information gap leads to overreactions by policymakers, the result can be soaring prices. IFPRI has developed a way to measure this phenomenon and make it accessible as a useful tool for policy makers. In August 2010, Russia banned wheat exports in response to ongoing drought and wildfires. As the figure (right) shows, in the period in which Russia imposed the export ban, futures returns for wheat showed three days of excessive, or abnormal, returns (that is, returns exceeded the threshold they stay below 95 percent of the time) – even when supply and demand factors suggest they should not have done so. At that time global wheat stocks stood at around 175 million metric tons – nearly 50 million metric tons more than in 2007–08. Russia’s export ban removed less than 18 million metric tons from the market – well below the 26 million metric tons held in reserve by the United States alone. Moreover, the United States – the world’s largest wheat exporter – had enjoyed a good harvest.
When information on the US harvest and existing stocks became available, prices immediately dropped. US wheat production could easily have covered the gap in exports from Russia, and if this information had been known sooner, global wheat prices should not have increased substantially. The media overreacted to the news of Russia’s export ban and failed to explain that global wheat production and stocks were sufficient to compensate for the loss of Russia’s wheat. Moreover, every piece of news during August through October 2010 – even the US Department of Agriculture’s better-than-expected projection that the world would harvest only 5 percent less wheat that year than the previous one – seemed to elicit a spike. The number of media articles on the price of wheat rose significantly between August and October 2010, and 57 percent of the total number of media articles with any reference to wheat prices reported that wheat prices were going to increase. This number was 93 percentage points higher than the same measure in an average quarter for 2010 (see table right).
Among the major reasons for the price increases reported in the media were the fires in Russia (62 percent) and low inventories because of low production and stocks (25 percent), even though the inventories and stocks were sufficient and significantly higher than in the 2008 crisis. Only 7 percent of articles referred to policies, such as export bans, which had in fact been the major reason for the increase in prices.
This lack of information on global production led governments around the world to engage in panic buying that exacerbated the situation and pushed up prices.