Speculators and Index Funds Don't Control Grain Markets

Global governments continue to debate whether speculators and index funds are responsible for huge gains in commodities lately – including the grains. Since April, the United Nations reports that over 30 countries are in the midst of food riots caused by rice shortages. The grains, including rice, have more than doubled over the last 18 months. From their lows in 2006, the grains complex has more than tripled in value.

No doubt, soaring grain prices are having an adverse effect on food distribution and affordability, especially in the Third World.

But are speculators mostly responsible for food shortages? The facts point to a different scenario altogether; hedge funds and index funds might cause prices to rise over the short-term, but it remains highly unlikely traders control the long-term direction of any market, including the grains.

Bad weather, soaring input costs, bio-fuel production and booming global demand are far more fundamental variables affecting grain prices.

The U.S. and Australian planting season is off to a poor start in 2008. Bad weather is mostly the culprit, not a bunch of hedge funds and index funds.

American corn and soybean farmers are suffering from too much rain while Australian wheat farmers have been plagued by drought since 2007. American farmers are planting 324 million acres, or 131 million hectares this year – up 4 million acres from 2007, according to the U.S. Agricultural Department (USDA). Despite more land devoted to corn and soybeans, harvests remain poor. Only wheat is more abundant compared to 12 months ago and prices have corrected sharply since last March.

American farmers are among the world’s leading producers of coarse grains, supplying 60% of global corn exports, one-third of soybeans, a quarter of wheat supplies and 10% of global rice production. Though global wheat yields are forecast to rise 8% in 2008, bad weather might still hold back production in Australia following a brutal two-year drought.

Most of the best arable land is now waterlogged, including Illinois, Iowa, Wisconsin and Minnesota. U.S. soybean plantings are now 16% behind last year’s crop yield while in Arkansas, which produces almost half of America’s rice -- yields have been delayed because of bad weather.

Governments can influence the near-term direction of markets through legislation – usually unhelpful and sometimes even disastrous. But in this case, trying to fix the food problem by pointing fingers at speculators is utterly ridiculous. Where was the government ten years ago when the grains were collapsing? Were speculators blamed for shorting corn and soybeans in the 1990s? Of course not.

Soaring food inflation is indeed a concern. But the government and regulators are barking up the wrong tree. If you want to complain, lodge a formal complaint with Mother Nature, not the speculators, which help make markets more efficient and suffer the consequences of profitable or unprofitable trades.

Have a good weekend.

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