I write regularly in this space about the price of grains and their relationship to milk, because, as a colleague once put it, milk is just liquid corn. The dairy markets gyrate from day to day, but, over the long haul, the price of milk will reflect the cost of production.
Not only are corn prices higher than ever, they’re also more volatile, making it a challenge to manage price risk on the farm. Theories abound: increasing meat consumption in China and India; diversion of corn for ethanol; more extreme weather; lack of buffer stocks.
A new paper from the New England Complex Systems Institute (NECSI), an academic research center based in Cambridge, Mass., says that financial speculation trumps them all. Following the collapse of the mortgage and stock markets in 2007 and 2008, the authors conclude, investors shifted assets into commodity index funds.
According to a United Nations report, holdings in commodity index funds increased from $13 billion in 2003 to $317 billion in 2008.
The unintended consequence of this investment is that cash floods in and out of these funds, causing bubbles that may or may not be tied to actual supply and demand, the researchers say. To be clear, little, if any, of this outside money has dairy derivatives in its portfolios. But its effect on grain prices, and on volatility, is worth a deeper look.
By the way, NECSI didn’t let ethanol off the hook. While the report attributes boom-and-bust volatility to outside investment, general food inflation over the last seven years is attributed to ethanol conversion.
These arguments aren’t new, nor is there a consensus. Provisions of the Dodd-Frank Wall Street Reform bill currently under debate are intended to impose position limits to prevent excessive speculation on commodities. But regulators, lawmakers and financial institutions are still negotiating the implementation.
In the meantime, volatility will continue, regardless of the reasons. Corn futures increased 15% in August, then fell 15% in September. How much of the September crash was due to corn supply-and-demand fundamentals and how much was part of the broad commodity and equity sell-off that roiled global financial markets?
And dairy? It seems dairy sold off at about the same time. Yes, we can point to some fundamental reasons: domestic consumption has softened, global demand has eased and global production has come on strong. The timing, however, makes one wonder.