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Investment

Is speculation behind volatile food prices?

"Hunger-makers" is the term critics use for speculators who trade with foodstuffs. These traders have a bad reputation. But the tradition of making business with raw materials goes back a long time.

The commodity futures exchange New York Mercantile Exchange (NYMEX) resembles a fortress sitting on the southern tip of Manhattan. On the trading floor behind an unimpressive beige-colored façade, dealers trade with cotton and crude oil, and with foodstuffs like coffee, cocoa, or sugar. But these are difficult times for NYMEX. Speculating with foodstuffs has fallen into disrepute over the last years. Gambling with commodities is unethical, say critics. They call banks and funds that speculate with prices for foodstuffs "hunger-makers".

Speculation with foodstuffs is not a new phenomenon, however. "It goes back to the old Romans and Greeks," said Kara Newman, a New York-based author. In 2012, she published the book "The secret financial life of food." Such speculation initially served the purpose of security, said Newman. "This way producers would safeguard their products and protect themselves against potential disasters or a foodstuffs surplus in the future."

Author Kara Newman: "The Greeks and the Romans speculated with raw materials"

Commodities bubble

Producers and clients sign so-called "futures contracts," which oblige both parties to deliver or buy a certain amount of commodities at a specified date in the future. Nobody can foresee whether or not the price agreed today will change until that date. That's where speculators come in who take on the liability for price volatility. Naturally they hope to make profits.

For a long time, foodstuffs markets were considered stable. But over the past five years, commodities prices skyrocketed at first, and then took a drastic hit. Observers speak of commodities bubbles. Where do these fluctuations come from?

Rules that are no more

The headquarters of the anti-starvation organization "Why Hunger" is situated in Manhattan. Their activists started noticing unusual price fluctuations on the foodstuffs markets in 2008, said campaigner Siena Chrisman. "Our experts told us they were down to a deregulation of the raw material market and a new, extreme kind of speculation."

In the past, commodities and foodstuffs in the US would solely be traded on the two big futures exchanges in New York and Chicago. But many of the old rules have since been suspended. The observers say that development started in 1991, when the industry began advocating commodities assets by introducing a so-called "Commodity Index." Gradually, the market was opened to private investors.

Commodities trade similar to stocks trade


Bild: DW/Janosch Delcker, New York,

Campaigner Siena Chrisman: "Extreme speculation causes volatility"

"We had the considerable luck of seeing the introduction of so-called ETFs, exchange-traded funds, which invest in raw materials," said George Gero. He is a trader with asset manager RBC and has more than 30 years of experience in trading at NYMEX.

In principle, ETFs trade with raw materials in much the same way as you trade stocks or bonds. The first raw material ETF was introduced in 2004, and the number of funds has since risen to hundreds. Gero has his office on the 33rd floor of a glazed high-rise in Midtown Manhattan. On the wall behind his desk is a photo the size of a poster. It shows him on the trading floor of NYMEX in the middle of a bustling crowd of traders in 1985.

The photo seems like a relic from different times. A small share of deals are still done with traders shouting and using hand signals on the floor itself, but the large majority of trade now happens electronically. That combined with the opening of the markets meant that the number of speculators involved in futures trade rose steadily.

Private trade in particular makes it difficult to gain information, said Lucas Bernard. "Transactions are gaining a life of their own." The economist is a lecturer at the City College of Technology at New York City University. At the end of last year, he developed a model about raw material trade together with two fellow economists. They speak of a "financialization" of the raw material market. In other words: the trade with raw materials is now following the rules of the financial markets.

Trader George Gero: "We were lucky to see the introduction of exchange-traded commodity funds"

Volatility in the market

Among the most important investors in raw material markets today are big players like pension funds. They heard the alarms bells ring when the global economic crisis started in 2007 and consequently tried to find ways to reduce the risks from stock and bond markets. They started investing in raw materials, where the markets at the time were considered relatively stable.

But even the raw materials markets, which used to be fairly manageable in the past, have now become more volatile. So much so that some investors have already lost interest in them again. According to US business daily Wall Street Journal, investors from US pension funds and other institutions have over the past two years withdrawn almost $10 billion (7.7 billion euros) out of tradable indices connected with raw materials. Calpers, the biggest pension fund in the US, sold 55 percent of its assets in raw material indices last October, for instance.

Responsible for hunger?

Trade with raw materials, especially trade with foodstuffs, is criticized like hardly any other financial product. "Studies by economists at the Massachusetts Institute for Technology, the World Bank, the International Monetary Fund and the UN have all established a connection between raw material speculation and heavy volatility in foodstuffs prices," said campaigner Siena Chrisman from "Why Hunger".

Economist Lucas Bernard: "Transactions gain a life of their own"

Many share Chrisman's critical view. The campaigners do acknowledge that many factors contribute to rising or falling foodstuffs prices: good and bad harvests, oil production, rising and sinking demand, or simply the weather. But heavy fluctuations can be attributed to speculation, critics are convinced.

Science fails to provide proof

Not everybody agrees. In December, 40 German professors wrote an open letter in which they stated that science has yet failed to prove the connection between speculation and price fluctuations on the foodstuffs market. But there's one thing everybody agrees on: some of the investors on the foodstuffs market today pursue interests that have little to do with the original function of speculators.

DW.DE