Gerdien Meijerink

Karl Shutes

Why are food prices high?

Date

Ind

ex

Va

lue

100

120

140

160

180

200

220

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Food Price Index (Monthly 1990-2011)

Source: FAO

Cereals Price Index

Date

Ind

ex

Va

lue

100

150

200

250

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: FAO

Source: FAO

Food Expenditure

Source: ERS/USDA

Food prices

Why are food price so high?

Supply Underinvestment in agri-sector Extreme events eg weather shocks

Demand Macroeconomic factors Changing patterns of demand Alternative uses eg biofuels

Stock levels Act as a buffer to counter shocks

USD- Euro etc Trade Policies

Import/ Export bans Speculation Political economy factors

Global grain production and consumption

Source: USAID, 2011

Global stocks to use ratio

Demand for Commodities

Source: Wright, 2009

Potentially made worse by time lags in crops

Stocks To Use Ratios

Source: FAO

Year

Sto

cks

To

Use

Rat

io

20

25

30

35

1990 1995 2000 2005 2010

Crop

Corn

Wheat

Hig

h P

rices

Low

Pric

es

Hig

h P

rices

Source: USDA

Export restrictions (rice market)

Source: Heady, 2010

Corn Prices (Daily data 1999-2010)

Who are Speculators?

There is no single answer A trader who seeks to earn profit and in doing so takes

on (additional) risk Whereas a hedger is looking to minimize their

exposure to certain risks Not a mutually exclusive group

Can be classified by the types of trade• Scalping- minute to minute trades• Day traders- a view over a day with no overnight position• Position traders- hold alonger position either outright or spread

Corn CBOT Open InterestLong Positions Short Positions

Open Interest: is the total amount of all futures contracts entered into and not yet offset by a transaction, delivery, excercise, etc (CFTC)

CFTC Definition Commericals

Dealers/ Merchants Manufacturers Agricultural or Natural Resource traders Producers Swap and Derivative Traders (moved category in other

data) Non-Commercials

Hedge funds Floor brokers Non registered participants

Speculation is risky: Tony Ward

Bought 241.000 tonnes of cocoa (about $1bn) Crops better than expected

Political impact reduced Prices fell 25% since delivery in August

Speculative Instruments

OTC (Over The Counter) Forwards

• Delivery at a price set now

Swaps• A fixed price is exchanged for a fixed price• Similar to a portfolio of forwards of different maturities but the same

fixed price

Exchange based Futures

• Standardised forward (approximately)

OTC Potentially higher counter-party risks of defaulting Problems with price transparency Double coincidence of wants

Exchange trading High leverage

• Exposure to price movements can be very high

No double coincidence of wants

Current Research

Does speculation cause high food prices? Causality is used in a very specific sense of temporal

ordering• Atheoretical time series framework• Christmas cards Granger cause Christmas

Better interpreted as leading not causing Evidence of a latent variable

• Some extra missing factor that is not included in the analysis

Speculation Causes Price Rises

Cooke & Robles (2009) Monthly prices- wheat, corn, rice & soybeans Macro data included eg USD-Euro Short time series

• Low power• Structural breaks in series further reduces span

Speculative proxies Granger caused food price rises until the food crisis and then ceased to have explanatory power

Robles, Torero & von Braun 30 month rolling analysis on monthly data Speculation proxies: net positions, non-commercials to

reportables Granger causality found in wheat, maize, soybeans &

rice for some of the proxies• No single proxy was found to be significant across commodities

Gilbert (2009, 2010) Granger causality tests in a number of markets Funds appear to be a mechanism for transmitting

information about, for example Chinese economic growth rather than a cause of and in itself

Common factors might account for some of the findings

Speculation Does Not Cause Price Rises

Harris & Buyuksahin (2009) Oil speculation volumes are Granger caused by price

changes Speculation follows the trending prices & does not

create the trend

Sanders, Irwin etal (2008, 2010) Theoretical linkages not demonstrated

• Money moving into the market does not constitute demand except through the belief that this constitutes new improved information

• Impact on Spot by participating in only derivatives markets• Price rises occurred in markets without speculation

Granger causality tests on weekly returns and volatilities suggest the hypothesis of Granger causality is not accepted in a majority of cases

Working’s measure of speculative activity• Speculators required to meet liquidity and hedging needs• Long only funds meeting unbalanced short hedges• No large changes in the measure over 1995-2008

– Corn ranged from 1.06 to 1.13

Summary

Empirical evidence is inconclusive: Granger causality is not causality

Need theory to explain link between futures prices and cash prices (often missing in studies)

Theory: spot prices drive futures prices, not the other way round

LEI’s Ongoing Research

Econometric multivariate model examining the role of cross correlations in the returns on a broader universe of commodities and equity The funds are interested in a diversified portfolio Portfolio correlations are going to be important in their

decisions Modelling time varying risk premia explicitly

Research on trade restrictions Update on the 2008 report “why are food prices

so high?”