Dan Ettling – Sept 3, 2008

In prior articles I’ve discussed the global grain and oil seed market, the factors that impact it such as fuel cost, transportation etc., and the ethics of using food commodities for alternative uses. The other major variable in the food cost equation that demands evaluation is the “speculators”.

The importance of understanding the speculators on the market is fairly simple. Producers have the right to sell and speculators have the right to purchase in advance.  In either case the seller hoping to get a better price early and the speculator hoping to sell at a better price later. This is not an unhealthy market practice unless the speculation begins to compromise, and even falsify, the projected value of the commodities. We all know these advance purchases as futures.

For example, in the next 60 days or so of the writing of this article, many farmers will be making a decision concerning whether or not to commit their acreage for a fall planning of Hard Red Winter wheat or commit their land to corn. They make this decision based on the projected value of the commodity at the time it is to be harvested. They need to have hard market data by which to make these decisions. At the point that the amount of money and percentage of crop speculated upon is such that the value of the commodity is altered from the value that the market would otherwise have yielded, proper decisions on the part of the farmer become difficult. Simply put, when the price of the commodity as futures is falsely above or below the fair market price at the time of the availability of the commodity, the farmers no longer has the ability to plan their production properly and the market itself begins to break down. This condition has a significant negative impact on the market.

Many commodities, and producers thereof, are currently suffering this condition of divergence between futures bought ahead of time, and cash value upon actual trade of the commodity. As the prices of various commodities increase due to this volatility, the cost of energy and petroleum based fertilizers increases etc., speculators have more incentive to increase their activities in pursuit of the exaggerated values.The assumption is that if we get convergence under control, buying and selling would be predominantly based (once again) on reasonably predictable market positions that the farmers have always been used to, and less so on the more volatile results of exaggerated speculation.

I’ll use wheat, the flour and water baker’s primary ingredient, as an example of what is being done about this problem.

As a result of increased concerns about diverging futures and cash positions with regard to wheat, the US Government has made it clear to the Chicago Board of Trade that we need to see convergence on price. This was being talked up most loudly in Spring 2008, when the prices were high, and had risen sharply.

Industry experts that I talk to is that the Board of Trade aren’t sure about how convergence is to happen: all agree it needs to be done, and would rather see the market correction than well intended government involvement. Limits may be placed on the amount of index money going into the market. In order to have hedgers there must be speculators, yet limits can be placed to ensure that the impact of the activity isn’t in opposition to convergence.

Dan Ettling is a Bakery consultant for MonkeyMedia Software and International Bakery Consulting Services.

Stock market photo by Patrick Beek

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