The life of commodity speculators

The food rush

Commodity speculators have moved into food - with dire consequences for the world’s poorest. Hazel Healy finds out how it’s done.

New Internationalist

‘The world is on a knife edge in terms of supply and demand,’ proclaims agricultural derivatives trader Bill Plumber. ‘If we have a crop failure, honest to God, I don’t know how the world is going to handle it.’

Gold dust: a Malawi village gets a delivery of maize. Its price on international markets has trebled in the last decade. Mikkel Ostergaard / Panos

Bill is speaking on a ‘hedge fund TV’ video channel, where legends of the managed-money trade share their wisdom. He goes on to explain how he’s going to handle food scarcity – to his advantage. ‘As an ag trader, I’m looking forward to the most exciting years in my career. Instead of boom and bust, it’s going to be boom and back up again.’

Glued to screens in London’s square mile, Canary Wharf and Wall Street are thousands of traders who, like Plumber, are working on the assumption that, pretty soon, there will not be enough food to go round.

Banks have designed products to get consumers and pension funds to bet on products as diverse as aduki beans, greasy wool and ‘leveraged soya beans’. Uptake is high. This year, 

investments in food derivatives stood at $126 billion, compared to $3 billion in 2003.

But there is one hitch to the ‘ags’ bonanza. The top three food (or ‘soft’) commodities – wheat, rice and maize – are also the staple diet of the world’s two billion poorest people. And since high-finance got in a frenzy about food, one billion – a seventh of the world’s population – cannot afford to eat.

Children stop growing

Since powerful, new investors started pouring money into food markets, prices have been behaving in strange ways. Markets are aggressively volatile: wheat shot up by 46 per cent in three weeks in January and February of 2008, fell back completely by May and was up again by 21 per cent within the month.4 Maize has surged by 102 per cent in the year to April 2011. Steady upward pressure pushed food prices up by an average of 83 per cent between 2005 and 2008.

High prices translate directly into misery and malnutrition.

In poor households in the developing world, food can account for 70 per cent of income, leaving families with stark choices. People eat fewer and less nutritious meals, cut back on healthcare and schooling. Children stop growing, as malnutrition takes it toll. The World Bank estimates that since June last year, food prices have catapulted an additional 44 million people into poverty and hunger.

Getting rich off hunger is immoral. But causing hunger is nothing short of murder. Naturally, banks are quick to deny any correlation between the billions of dollars flooding food markets and the under-fives dying of malnutrition. They say prices reflect a squeeze on supply caused by failing harvests and a run on demand caused by biofuels, China’s appetite for meat and a growing world population.

‘Yet Olivier de Schutter, the United Nations Rapporteur for the right to food – who is concerned with feeding people, not making money from money – says these factors are, at best, minor catalysts. Instead, he maintains, the wild fluctuations and price inflation are caused by a ‘speculative bubble’.

But how did investors get their paws on the world’s food supply in the first place? Who exactly is doing it and how? To find out, I decide to invest in one of the products advertised on an online investment site promoting agriculture as ‘the new gold.’

I should first come clean as a die-hard, risk-averse investor. The biggest financial gamble I ever took was to open an ethical savings account, long since emptied. But after just minutes of googling, I discover a ‘Trade for a Pound’ ad, which shows an overweight man scrambling for coins down the back of the sofa. This turns out to be the gateway to an online trading account.

Before long I am introduced to a product called The Agriculture Booster that includes a mix of commodities, most of the ingredients of your breakfast: wheat, corn, sugar and coffee plus the cotton in your tablecloth. The pull of this ‘Simple. Secured. Liquid’ investment, a helpful man called Steve from Deutsche Bank explains, is that I can get exposure to commodities without the bother of actually having to take physical delivery of, say, a tonne of wheat.

The Booster derives its value from the underlying asset of food prices. The past performance graph shows that it peaked during the 2008 food crisis and again in January this year: this is a bonafide way to profit from hunger.

Back to the futures

The Booster is based on something called a ‘commodity index’, which was pioneered in 1991 by the canny and opportunistic investment bank Goldman Sachs.

Their index melded together 24 different raw materials – agriculture, energy and metals – transforming them into an asset that performed like a stock or share.

The index tracked futures prices on the commodity derivatives exchanges. When these markets were tightly regulated they functioned well – reflecting supply and demand – and the real price of wheat declined. But in 1999, after intense lobbying, the US Commodity Futures Trading Commission relaxed the rules. Banks – such as Barclays, Deutsche Bank and JP Morgan – were now allowed to hold as large a position10 in food futures as they liked.

Indexes took off when other investment areas dried up. The dotcom crash in 2000, the US property meltdown in 2006, the global financial crisis in 2008: these all sent pension fund managers on the hunt for new, safe places to grow their cash. Trades in commodity indexes increased 50-fold in a decade, hitting $376 billion by 2010.

A bewildering range of products has sprung up to allow investors to bet on these index funds. Many deals are done by swaps, or ‘Over The Counter’ deals, private arrangements between banks and clients that are not open to public scrutiny.

The main route into food derivatives for consumers and institutional investors are Exchange Traded Funds (ETFs), like Deutsche Bank’s Agriculture Booster. The agriculture elements in ETFs leapt by 35 per cent in six months to reach $15.7 billion at the end of June 2011.

Futures Exchanges

Financial speculators bet on the price of foodstuffs by trading in derivatives called ‘futures’.

Futures contracts were originally designed to allow farmers to sell their harvests in advance at a fixed price, allowing both buyers and growers to hedge against risk.

Over time, food futures came to be traded on commodity exchanges, such as the Chicago Board of Trade. This is where financial speculators get involved, to bet on the future price of commodities such as maize, lean hogs or pork bellies.

They do not plan to take delivery of say, a tonne of wheat, for milling into flour, or a hog of any shape or size.

Traditionally, speculators played a minor role in these food derivatives markets. But in 1999, the finance industry lobbyists secured de-regulation. In the last decade, vast sums of capital have flooded into food futures.

Footloose and FTSE-free

In early August, just as $3 trillion was wiped off the value of world shares, I make like an investor and join the food speculators.

I buy 10 securities for $14.40 each and watch as the graph begins its vertical climb.

Before long I am checking the Agriculture Booster compulsively. I get the heady rush I remember from a visit to a Panama casino. Since I bought-in, Google ads pop up all over the internet as I browse, encouraging me to spread-bet and play Black Jack.

The line of the graph has long stopped representing the price of food, and I can’t help willing it upwards.

But as divorced as I may feel, my returns are tracking the ups and downs of food derivatives. And this brings us to another of the banks’ arguments: that a bet on the price of something cannot influence the real price.

To understand how it could be that derivatives do drive up the price of food, I travel to the City of London, the world’s second largest agricultural commodities market, to find out what the traders think.

Squaring up to the square mile

Barclays Capital and Deutsche Bank have declined to comment, but a leading fund manager has agreed to speak to me on condition of anonymity.

Before the interview I climb the Monument to the Fire of London. Looking out over the square mile with my heart pounding from the 311-step ascent, I vaguely wonder whether I’ll get to see my Agriculture Booster blinking on a screen at the London International Financial Futures and Options Exchange (LIFFE).

On my way to the meeting, I see mudlarks picking through the piles of rubble on the banks of the Thames. Ten feet up, a personal trainer is directing two women through a strenuous work-out on mats laid out on the concrete.

Dark-haired café staff in uniform walk alongside quick-stepping men in suits and women in smart heels through the ancient heart of London, its streets evocative of centuries past: East Cheap, Pudding Lane, Threadneedle.

On one of these streets I meet up with a fund manager – let’s call him Mike.

He patiently explains I won’t see my Booster anywhere, as it’s traded electronically on desks. Instead, he downloads a Bloomberg App on to my mobile phone so I can see it blinking there.

Mike is an experienced commodities trader, who ran a sugar hedge fund in the 1980s. He’s in no doubt that these commodity funds and my Booster are pushing up prices. ‘Of course,’ he says, ‘because it’s pushing demand, and that pulls supply out of the chain.’

Blowing bubbles

A closer look at the small print on my Booster tells me that before my futures contracts expire, they will be ‘rolled’ over into a ‘longer dated contract’. This is key to understanding the artificial pull on prices.

It means that the index is structured to buy futures automatically, on the assumption that prices will rise.

Against the grain: Chicago Board of Trade rice pit. Orjan F Ellingvag/Dagens Naringsliv/Corbis

When a flood of investors keep on buying, experts say, it creates a ‘demand shock’ in the commodities exchanges, pushing up the cost of futures.

Taking their price signals from the exchange, traders on physical markets delay sales and hoard reserves in anticipation of higher prices. Panic buying starts and countries impose export bans.

The index fund manager is effectively hoarding futures contracts, triggering real-life hoarding that makes the bet on rising prices a self-fulfilling prophecy. Even when the commodities crash comes – as it did in 2008 – the process simply begins all over again.

Mike believes that, as with property before it, there’s a food bubble growing. He uses the word ‘timebomb’.

These products have a psychological appeal. ‘People could relate to the desire to own property. In the same way, they’d like to own commodities. They empathize with it – after all, we all have to eat.’

The story of tightening demand is just another way for banks to get their hands on extra money. They only have to put down a fraction of my cash to buy a food future, the rest will be lent on or invested – for better returns. He points out the bank charges: 0.45 per cent management fee and 0.16 per cent collateral fee.

Before leaving, I ask him about the ethics of this kind of investment. He smiles and tells me ‘it’s like the rioters’ (who ransacked London’s shops around the time I invested in food).

‘The rioters?’

‘They get caught up in the action. They don’t think about the ethics until later.’

Complex. Risky. Wrong

Next I ask one of Britain’s leading economists, Financial Times columnist John Kay, whether he believes food prices are being pushed up by big investors.

‘I think it’s very likely true,’ he says. ‘Investment banks are bound to say it isn’t. They’re making a lot of money out of it,’ he adds dryly. ‘Fund managers are under less pressure to lie.’

It’s hard to prove. ‘But if one looks at what’s been happening, it seems very plausible,’ he says. ‘I find this idea that it’s because Chinese people are eating more meat to be very unconvincing.’

Kay’s views are supported by data from the US Department of Agriculture, which show no shortfall or excessive demand in maize or wheat when prices rocket skyward.

We do some more head-scratching over my DB Agriculture Booster. I’m beginning to wonder whether anyone truly understands this thing. Closer reading tells me the product is created through a swap contract and ‘fully collateralized by gold bars’, which (and this next bit comes in tiny writing) can sometimes be ‘replaced by financial securities’.

Kay jumps on this as a new ethical concern with the Booster. Banks have to put up collateral against my investment so that I can get my money back, ‘but they put up stuff that’s illiquid [unsellable] rubbish.’

In other words, Exchange Traded Funds (ETFs) like mine are opaque products that distribute risk in weird ways – like the ones that helped prompt the last crisis.

‘If there’s another blowup – which there will be – ETFs will aggravate things and send them spiralling,’ Kay concludes.

‘Cheetahs, a new breed of cat’

But we can’t blame all the mountainous ups and downs on my risky Agriculture Booster. Investment banks, hedge funds and grain companies also use their own money to play the markets. This is a ‘traditional’ form of speculation, but one practised by ‘a new breed of cat’, according to Bart Chilton from the Commodity Futures Trading Commission (CFTC).

Chilton, with his knack for folksy nicknames, labels these traders ‘cheetahs’ because they are in and out of deals lightning fast. A bank may have a thousand mathematicians and physicists using algorithms to carry out this high-frequency trading.

The huge influx of speculators into food markets means they now outnumber commercial hedgers three to one on exchanges. And when markets are made up of speculators betting on each other, the herding instinct exerts a stronger pull than any information on wheat stocks. You only make money if you get the sentiments of the markets right. If you go the opposite way, you get wiped out.

The result is wild leaps in prices and flash crashes, and an outcry from the food industry. ‘Are these guys parasites on the market? I’m leaning that way,’ ventures Chilton.

My final line of inquiry takes me to the vice president of the National Farmers Union of Scotland, Allan Bowie. ‘As growers we’ve got to deal with the weather, global trade and now the city traders,’ complains Bowie, who also grows barley for malting into whisky. ‘In 30 years growing wheat, I’ve never seen volatility like I’ve seen over the last 18 months.’

He believes the markets are not working correctly. ‘It’s getting harder to know where the markets are going to go. It’s causing huge shifts in what’s grown. The balance is skewed,’ he concludes.

Asset liquidation

By mid-September it’s time to junk my Agriculture Booster. Over the last five weeks I’ve watched as it clocked up the percentiles, leaping by 7.4 per cent in three weeks, peaking at 9.0 per cent – before plunging back down again. It was a good reminder that volatile investments like this are gambling, pure and simple.

My mouse clicks on the little red ‘sell’ button, sold for $14.60. My modest $2.32 profit (1.6 per cent) is wiped out by $10.45 in charges.

But if I had invested $1million for a pension fund, a $16,000 profit would have done nicely. I’m reminded of a closing piece of advice from a ‘profit-munching’ advocate on MoneyandMarkets.com: ‘The ride can be rough – but the rewards can be super-sized.’

While I bet on commodity prices, famine had taken hold in Somalia. According to the World Bank ‘shortages and near-historic prices for staples such as corn, wheat and sugar have magnified the impact’ of an emergency triggered by conflict and drought.

Famine helps bring the activities of speculative capital into sharp relief. Our food system fails to feed the hungry at the best of times, without entrusting it to the same gamblers whose risky finance already brought about a global financial crisis.

And there is something particularly sick about wealthy and unaccountable élites increasing their fortunes in a way that stunts – and starves – children. This is raw-edged capitalism at its worst.

Starbucks vs Goldman

With ever-growing public revulsion at the excesses and arrogance of banks, time is ripe for a clampdown on speculation.

‘If the regulators get it right, and don’t cave in to pressure from Wall Street and the City of London, simple legislation will help stabilize food prices,’ says Deborah Doane from the World Development Movement.

Right now the opposing sides are squaring up. The powerful financial services lobby is backed by the OECD, International Monetary Fund and countries like the US, Britain and Brazil.

They face a hotchpotch of unlikely allies. Social justice campaigners, French President Nicolas Sarkozy and the Dominican Republic are calling for limits to speculation, and so are major companies hurt by the soaring cost of raw materials – such as Starbucks, the airline industry and food processing giant Unilever.

Food is for eating, not indexing, leveraging or ‘betting long’. Let’s get it out of high-finance and put it back on the plates of the hungry.