"Why are food prices high?" A presentation I held with Karl Shutes on 25 March 2011 organised by the Ministry of Economics, Agriculture and Innovation. A special focus on the role of speculation.

1. GerdienMeijerink Karl Shutes Why are food prices high?

2. Food Price Index (Monthly 1990-2011) Source: FAO

3. Cereals Price Index Source: FAO Source: FAO

4. Food Expenditure Source: ERS/USDA

5. Food prices

6. 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

7. Global grain production and consumption Source: USAID, 2011

8. Global stocks to use ratio

9. Demand for Commodities Potentially made worse by time lags in crops Source: Wright, 2009

10. Stocks To Use Ratios High Prices High Prices Low Prices Source: USDA Source: FAO

11. Export restrictions (rice market) Source: Heady, 2010

12. Recap of Banse, Nowicki & van Meijl Fundamental data Low inventories Supply side shocks such as weather Oil Prices Biofuel demand Role of Speculation?

13. Corn Prices (Daily data 1999-2010)

14. 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

15. Corn CBOT Open Interest Short Positions Long Positions Open Interest: is the total amount of all futures contracts entered into and not yet offset by a transaction, delivery, excercise, etc (CFTC)

16. 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

17. 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

18. 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)

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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?”