Food Commodity Markets


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An introduction to food commodity markets and futures.

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  • As you will see the food commodity markets are large, complex hairy beasts and there is not just one thing that that moves them in any direction. There are issues of population, inequality, income disparity and so much more that we did not dig into for this presentation. We focused mainly on market changes and impacts.
  • First let start with a little history - Futures transactions Started with trading rice in Osaka Japan (specifically in the town of dojima) in the late 1600’s, but it has not changed all that much in over 300 years - they had a trading floor and developed hand signals because of all of noise while trading. Food commodities are organized by contractsThese contracts are standardized contracts to buy or sell a specific asset. The contracts all have the same delivery date and quantity and specifications, the only thing negotiated is the price. The contracts are traded on a futures exchange like CME or ICE. Contracts include:Spot trading this is when you buy and sell in real time – you agree to buy it today and you take deliveryForward contract – is a contract to exchange at a future date for a price agreed upon today. You can’t get out of these contracts. Futures contract – these are standard contracts with little risk and they are liquid. You can decide you do not want the contract and then
  • First, there are different types of commoditiesAgricultural – Corn, wheat, cottonLivestock and meat – pork bellies, cattleEnergy – crude oil, ethanol Precious/industrial and rare metals – gold, silver, copper, nickel . . . Environmental commodities The principle regulator is the Commodities Future Trade Commission (CFTC), established in 1974. Legislation such as The Commodities Futures Modernization Act of 2000 and The Dodd-Frank Financial Reform Law.There are also many stakeholders in the markets
  • StakeholdersIn reality, food commodity markets serve sellers and middle-man buyers. Serving haves- rather than have-nots. Also - Not serving the planet’s production sustainability.
  • Before we answer the question of how to modify the market to account for all stakeholders, let’s examine some dynamics that skews the system.
  • Farmer may chose to forgo growing organic in favor of yellow corn #2 since it is traded and may fetch higher prices on the open market. Speculators help push up pricing on crops on open markets. Crops with higher shelf life are also favored due to tradability. Therefore, markets create adverse selection for these traits that are counter to a sustainable bio-diverse world.HALFof the food needs of the planet are now met by only four main crops: wheat, corn, rice and potato. Because of this farm system, 91% of maize varieties, 94% of pea varieties and 81% of tomato varieties have disappeared over the last 100 years in the United States (Fowler 1994). The erosion of biological diversity due to industrialized farming practices is a major environmental problem not only in industrialized nations but also in almost all farming systems across the world (FAO 1997). Industrialized farming practices displace local food varieties with exotic varieties, and intensify production of agricultural systems using agrochemicals, which results in large-scale habitat destruction. People relying on subsistence farming in Central Africa and drylands of Asia rely on local varieties of crops such as pearl millet, sorghum, cassava, and lentil (FAO 1997). In addition, species of semi-wild and uncultivated plants still form part of the diet of rural people in many parts of the globe. These plants play a major role during periods of food scarcity because they provide edible green leaves, berries and tubers (Pionetti, 2005). Unfortunately, these ‘minor’ crops have been bypassed by institutional crop improvement research programs and half of the food needs of the planet are now met by only four main crops: wheat, maize, rice and potato. Because of this farm system, 91% of maize varieties, 94% of pea varieties and 81% of tomato varieties have disappeared over the last 100 years in the United States (Fowler 1994). ). While food commodity markets is not the cause of industrialized farming, it creates and fosters a vicious circle whereby it generates ease of trade and demand for commoditized food, which converts more and more farms to mono-cultural, commoditized food production.
  • People relying on subsistence farming in Central Africa and drylands of Asia rely on local varieties of crops such as pearl millet, sorghum, cassava, and lentil (FAO 1997). In addition, species of semi-wild and uncultivated plants still form part of the diet of rural people in many parts of the globe. These plants play a major role during periods of food scarcity because they provide edible green leaves, berries and tubers (Pionetti, 2005).
  • Speculation affects food pricesratio is 1/3 speculationSpeculators take profit from trading and contribute little to value. Egypt Riots and Revolution - police brutality,[12]state of emergency laws,[12] lack of free elections and freedom of speech,[13] uncontrollable corruption,[13] as well as economic issues including high unemployment,[14]food price inflation,[14] and low minimum wages.[12]Other externalities affecting prices:Scarcity WeatherFuel pricesPolitical unrestTightening supplies and low stocksCountries limiting exports Putting food on the market you are selling to the highest bidder and creating disparity. We should all have access to food and prioritizing global trade over feeding people is unsustainable.
  • Dynamics of speculation – 3rd party index funds tied to food commodities.
  • Type of Hoarding:Commodity tradersHoarding - The purchase of large quantities of a commodity with the intent of pushing up the price. An investor hoping to increase the price of a commodity can do so by leveraging his or her demand for it, and buying physical inventory as well as purchasing futures contracts for that commodity.An example of hoarding’s disruption of the market place is an incident that resulted in the passage of the Onion Futures Act in the United States. In the mid 50’s two onion traders bought enough onions and futures to take control of the market and they were able to give the illusion of scarcity causing the prices to skyrocket.
  • Limiting or banning exports Another type of hoarding is limiting or banning exports by governments. Russia and the Ukraine, two of the top ten wheat producers in the world, banned wheat exports in August of 2010 causing prices to immediately rise.These countries made the bans out of fear that their wheat inventory would decrease because of bad weather and poor crop production. India, the second largest onion producer in the world, banned the export of onions until February 2011. These bans have sent ripples of food price increases throughout commodity markets and compromising the ability to afford food.
  • Biofuels are said to divert valuable food stocks to fuel
  • The extent of biofuels’ effect on food commodity prices is debatable, but biofuels have increased demand for certain maize and soybean commodities. There are factors increasing demand for biofuels as well: increase in oil prices, and policies favoring renewable energy such as the Energy Independence and Security Act of 2007 and the Energy Bill of 2005.The IMF (international monetary fund) estimated that the increased demand for biofuels accounted for 70 percent of the increase in maize prices and 40 percent of the increase in soybean pricesInformation from the U.S. Energy Information Administration 2002 – 2.1 billion2007- 6.5 billion gallons2009 – 10.76 billion gallonsThe USDA’s chief economist in a 2008 testimony before the Joint Economic Committee of Congress attributed much of the increase in farm prices of maize and soybeans to biofuels production -----------------------------------------------------U.S. accounts for about one-third ofglobal maize production and two-thirds of global exports and used 25 percent of itsproduction for ethanol in 2007/08.The U.S. has a taxcredit available to blenders of ethanol of $0.51 per gallon and an import tariff of $0.54per gallon,The U.S. expanded its biodiesel production following legislation passed in 2004which took effect in January 2005, providing an excise tax credit of US$1.00 per gallonof biodiesel made from agricultural products. This contributed to an increase in biodieselProductionThe large increases in biofuels production in the U.S. and EU were supported bysubsidies, mandates, and tariffs on imports. Without these policies, biofuels productionwould have been lower and food commodity price increases would have been smaller.
  • As you haveheard ,there are many factors that affect the prices of the food we eat. If you live and work in America you are lucky to spend on average less than 10% of our disposable income on food. Other people are not as fortunate- what a very small minority of people do in the markets has a great impact on the survival of many. Here are some ways of lessening the volatility of commodity pricing.
  • Market ChangesRaising margin requirements to reduce speculation and bring prices in line with natural supply and demand. The margin requirements for trading food commodities in the US are relatively low and not a barrier to entry for traders. The margins are currently 5-15% for food commodities. In comparison, margins for trading stocks are around 50%. Raising the margins to be more closely aligned with those of stocks would make it less attractive for investors, thereby limiting speculators and manipulation of the commodities market. This has been shown to work when CME Group, in an effort to reduce the number of default accounts and risk, raised margin requirements for silver. Speculation activity slowed and the market price for silver subsequently went down. The same can work for food commodities. Eliminating long commodity contracts while placing limits on the number of contracts held by institutional investors. Long contracts are those that do not take commodity delivery but are instead rolled-over to new contracts. These contracts are non‐responsive to changes in price. The contracts are held long term like a stock and actually remove liquidity from the market. Eliminating these long contracts would curtail speculation that does not contribute to liquidity.Increase Spot Markets To reduce speculation, spot markets should be increased. An increase in spot markets will essentially bring together buyers that plan to take delivery of the commodity and sellers that produce the commodity, which in effect removes the institutional investors. Removing the “middleman” will allow the market to function like originally designed. Increase Grain Reserve - Establish physical grain reserves. Physical grain reserves will reduce volatility in food price, manage risk in agricultural derivatives contracts, and eliminate excess speculation., Physical grain reserves and the abovementioned reform of commodity derivatives markets should be complimentary. The USDA’s Commodity Credit Corporation (CCC) is responsible for establishing physical grain reserves.Who? So these are some recommendations for creating a more sustainable financial market.
  • Carl levinwould establish speculative position limits on options, derivatives and swaps to commodities currently exempt and help curtail excessive speculation
  • 2 weeks ago (May 8th) French bank implemented robin hood tax.1 week ago Finland introducing it.
  • Market regulation requires a long time to implement. Governments, non-profit and social entrepreneurs such as Presidio graduates can leverage the current system to provide protection for its members without waiting for reform. Individuals, especially in developing countries, cannot afford to participate in the global commodities market due to lack of access, education and funds. A Group Food Fund can be created to ensure food affordability. By taking a specified percentage, such as 10%, of the income of group members, the fund managers can then hedge the food interest of the group by purchasing grain and related positions in the commodities market. A well balanced portfolio should hedge in related markets, such as fuel, in the right ratio to ensure that gains or losses in the investment follow real food prices on the market. This way, no matter the price direction, food will stay affordable for members. Another like method is food insurance. Larger institutions can provide food insurance on an elective basis to people in need. Like the Group Food Fund, the insurance also pools funds to hedge on the food commodities market, but provide a well understood instrument for large scale deployment
  • Sustainable food commodity markets should efficiently and effectively distribute global food supply and serve all stakeholders.A lot of changes are still necessary to make it work and serve underserved stakeholders. We talked about Market level changes.Beyond that is necessary - Revamp of the food systemWe believe an examination beyond the food market is necessary to create a system that is sustainable for all.
  • Food Commodity Markets

    1. 1. FOOD COMMODITY MARKETSPam Grey, Connie KwanCapital Markets, May 20, 2011
    2. 2. AGENDA Brief History and Set-up Why are Markets not serving all Stakeholders? Recommendations and Action
    3. 3. FOOD COMMODITY MARKETS Spot Forward Futures
    6. 6. SETTING THE STAGE Food is a basic right. Sustainable food commodity markets efficiently and effectively distribute global food supply and serve all stakeholders.
    7. 7. WHY ARE MARKETS NOT SERVINGALL STAKEHOLDERS? Product Uniformity Speculation Hoarding Biofuels
    8. 8. Food Commodity Markets adversely select formono-culture crops, threatening biodiversity andecosystem resilience.
    10. 10. Speculative trading creates the illusion of scarcity
    11. 11. SPECULATION IS GOOD SPECULATION IS EVIL Provides liquidity  Drives up prices to end consumer Physical goods follow real  Futures prices failed to converge demand/supply pattern at final with cash prices (CME, 2009) sale  Disrupts farmers’ and grain Speculation in all markets merchants’ confidence in futures within historical norms market Supporters:  Supporters:  Sanders & Irwin - Canadian  Childs & Kiawu – USDA Journal of Agricultural  Robles, Torero & von Braun – Intl Economics Food Policy Research Institute  Pirrong - WSJ  Levin – US Senate Sub-committeeSPECULATION: GOOD OR EVIL?
    12. 12. HOARDING  Commodity Traders  Control the Market  Onion Futures Act
    13. 13. Hoarding: Limiting or banning exportscan significantly affect market prices
    14. 14. Biofuels divert valuablefood stocks to fuel
    15. 15. BIOFUEL Increased Demand 70% of the Increase 10.76 Billion Gallons Tax Incentive
    16. 16. RECOMMENDATIONS Market Changes  Raising Margins  Eliminating Long Contracts  Increase Spot Markets  Increase Grain Reserve Actions  Letter to Commodity Futures Trading Commission (CFTC)  Robin Hood Tax  Social Programs
    17. 17. MARKET CHANGES Market Changes  Raising Margins  Eliminating Long Contracts  Strengthening Spot Markets
    18. 18. LETTER TO CFTC Limit speculative activity Membership requirement for participating Help Senator Carl Levin support section 737 of the Dodd-Frank
    19. 19. ROBIN HOOD TAX Combination Financial Transaction Tax (FTT), bank levy and The Financial Activities Tax (FAT)  0.05% from international bankers’ transactions  0.01% from currency transactions Raises £20 billion annually in the UK alone
    20. 20. SOCIAL PROGRAMS Group Food Fund  Governments, Non-profits, Grad students!  Balanced Portfolio to hedge against food prices Insurance  Scaled deployment
    21. 21. Food is a basic right.
    22. 22. REFERENCES