In an extraordinary meeting, FAO sizes up the turmoil in world cereal markets
The FAO’s Committee on Commodity Problems has just concluded its Extraordinary Joint Intersessional Meeting of the Intergovernmental Group on Grains and the Intergovernmental Group on Rice (held in Rome, 24 September 2010). The Food and Agriculture Organization of the UN does not, it appears, want to cause any alarm bells to be rung in countries already worried by food inflation, and that is why its overall advise is at odds with the details highlighted during the day-long consultations.
Here are the main points of an advisory titled ‘Turmoil in Global Cereal Markets: Outlook for 2010-11, Short-Term Risks & Uncertainties’:
La Nina (colder-than-normal sea-surface temperatures in the Pacific Ocean) often results in drier periods in Argentina and southern Brazil but wetter weather in Asia. It may strengthen through January
Any downgrading of wheat crops in southern hemisphere countries before harvest this year- Western Australia not so good
The final maize harvest in the USA (and China) – production may end up lower
Adverse growing conditions affecting secondary rice crops in Asia and main crops in southern hemisphere
Drought in Russia and delayed winter grain sowing (down 20%) – but some rains have arrived
Crop damage in Pakistan: implications for next season
Faster/slower economic recovery influencing demand prospects for feed and fuel: tightening maize supplies in the US if demand for ethanol rise faster than predicted
Larger than currently expected import purchases, maize by China for example
Trade measures, in particular further exports restrictions
Developments in outside markets such as currency (US Dollar), equity, energy and other commodity markets
The rhetorical question is asked – “Are we ready?” – and the points supplied are: (1) We are not in a food crisis and grain prices may even come down a bit, (2) But all indications point to still high prices and volatile markets with many uncertainties lying ahead, (3) Food security under growing market instability and price volatility: Are we ready?
The extraordinary joint meeting briefly explained what it meant by “Increased volatility & speculation” with the following points: Markets liberalisation, decline of price supports; Deregulation of the financial service sectorl Declining margins in securities tradingl Rising demand for food in emerging marketsl Under-investment in agriculture; Lack of price transmission to producers; Sudden governmental interventions in export marketl Ease of access to electronic market place; Exchanges restructured today as for-profit corporations.
The dangers, current and expected, are set out in the briefing paper on ‘Agricultural Futures: Strengthening market signals for global price discovery’. This said:
Volatility in commodity foodstuffs is a result of both fundamental factors and speculative inflows of managed money. Sharply differing opinions exist on how institutional money flows have changed the nature of the markets, particularly since the expansion of limits. While financial firms argue that they add volume and liquidity to the market, others maintain that large order size creates volatility and jagged price swings. In the August 2010 price hike of wheat, the CME wheat price moved up limit and down limit within two consecutive days. High frequency trading is also a controversial issue – one that a CFTC editorial recently stated needed “reining in,” commenting that “parasitical trading does not truly contribute to fundamental market functions.”
Much debated also is the effect of passive fund money (index funds and swaps dealers), with experts on both sides arguing whether they have caused chronic price elevation and steep contango in some futures contracts. In its 2009 Trade and Development Report, UNCTAD contends that the massive inflow of fund money has caused commodity futures markets to fail the “efficient market” hypothesis, since the purchase and sale of commodity futures by swap dealers and index funds is entirely unrelated to market supply and demand fundamentals, but depends rather on the funds’ ability to attract subscribers. Despite the risk transfer nature of futures trading, in which gains and losses are equally offset, passive funds have successfully packaged and sold futures contracts as an alternative investment class to institutional investors. However, most would agree that these passive funds do not affect volatility levels since their only trading activity is a forward “roll” of their positions and the timings of these rolls are announced in their prospectus.
This is worrying because the FAO is now being a great deal clearer about the same problem it tried to describe in 2007-08,
Finally, Olivier de Schutter, the United Nations Special Rapporteur on the Right To Food, has released a briefing paper entitled ‘Food Commodities Speculation and Food Price Crises: Regulation to reduce the risks of price volatility’. His recommendations:
1. Given the numerous linkages between agriculture, oil, and other financial markets demonstrated above, comprehensive reform of all derivatives trading is necessary. The very first step would be to require registration, as well as clearing to the maximum extent possible of OTC derivatives, so that there is real time reporting of all transactions made, without information privileges for OTC traders, and in order to allow for effective supervision. The small minority of derivatives that cannot be cleared must nevertheless be reported without a time lag.
2. Regulatory bodies should carefully study and acquire expertise in commodity markets, instead of regulating commodity derivatives and financial derivatives as if they were the same class of assets. It may be appropriate to assign the task of regulating commodity derivatives to a specific institution staffed with experts in commodity regulation, rather than have a single body regulating both financial and commodity derivatives.
3. Access to commodities futures markets should be restricted as far as possible to qualified and knowledgeable investors and traders who are genuinely concerned about the underlying agricultural commodities. A significant contributory cause of the price spike was speculation by institutional investors who did not have any expertise or interest in agricultural commodities, and who invested in commodities index funds because other financial markets had dried up, or in order to hedge speculative bets made on those markets.
4. Spot markets should be strengthened in order to reduce the uncertainty about future prices that creates the need for speculation. However, these markets must also be regulated in order to prevent hoarding. Spot markets must be transparent, and holdings should be subject to strict limits in order to prevent market manipulation.
5. Physical grain reserves should be established for the purpose of countering extreme fluctuations in food price, managing risk in agricultural derivatives contracts, and discouraging excess speculation, as well as meeting emergency needs. Such measures and the abovementioned reform of commodity derivatives markets should be seen as complementary.