Nothing gets politicians’ backs up more about the financial markets than when they’re perceived to be holding the “man on the street” to ransom. This summer’s spike in wheat and corn prices, and the resulting fear that there might be a repeat of the 2007/08 global food crises, has European financial regulators in a combative tizzy.
Last month EU internal market commissioner Michel Barnier – himself a former French agriculture minister – announced that the European Commission intended to introduce more stringent oversight of the commodity derivatives markets (see Barnier warns markets off reg arbitrage), with a particular focus on agricultural contracts.
The EU agriculture commissioner, Dacian Ciolos, told delegates at a Mifid conference in Brussels last month that European regulators should consider position limits on futures exchanges to counter excessive movements in commodity prices. This would mirror moves by the US regulator, the Commodity Futures Trading Commission, which had imposed limits in its jurisdiction as part of the Dodd-Frank legislation.
The CFTC itself hasn’t been able to produce the evidence that excessive speculation is the cause of price spikes. But pressure came to bear from politicians who blamed speculators for the spike in oil prices in the summer of 2008. According to a Freedom of Information Act request from the Wall Street Journal, the agency’s deputy chief economist, James Moser, wrote in an email to colleagues in August 2009 that it was pointless to devise solutions to a problem that might not exist. He added that there was no statistical evidence of a problem. Ditto for the UK Treasury and the IMF, which also conducted studies on this issue.
What politicians often cite to support their arguments against derivatives markets is that they are a multiple of the physical trading of the product. For instance, trading of oil futures is about 35 times the volume of physical trades. Some market participants fight back, claiming that the debate on speculation, from those participants outside the physical trading of commodities, is based on fiction.
According to Barclays Capital, the scale of investment activity in commodities has been hugely exaggerated and based on an inaccurate methodology. It estimates that annual inflows from investors into commodities amount to less than 0.25% of the total value of all commodities produced around the world annually; in other words, a tiny fraction. Secondly, it is often assumed that futures markets open interest held by investors is directly equivalent to additional physical demand and there are often scare stories about investors hoarding commodities. That’s simply not true, says Barclays. Ultimately, price determination will always come back to the physical supply of and physical demand for the commodity. Without exception, commodity derivatives are based on the price for a physical commodity, which is produced and consumed on a global basis.
The reality is that we live in an increasingly global system, and it is that system that has driven growth around the globe in recent decades and thus the rising demand for commodities. Most recently the focus has been on spikes in the price of wheat and corn, and the reason for this is simple: a big increase in living standards in China, leading to growing demand for basic foodstuffs. At the same time, the world’s third-largest wheat exporter, Russia, has recently banned exports. Little mention is made of the fact that global inventories of corn as a percentage of usage are at a 15-year low.
In the scheme of financial markets, commodities as an asset class is a fairly new game, with relatively poor data gathering. There is no doubt that something must be done to curb excessive price movements but shooting the messenger, the futures markets, without any evidence to suggest that activity in those markets is the cause is like shooting fish in a barrel.
