Volatility in agricultural commodity prices has for a long time been considered cyclical and, since the 2007/2008 crisis it has been the subject of particular attention from international policy makers and experts.
Its structural dimension, coupled with the complexity and diversity of its explanatory factors have also been the subject of many national and international debates for several months. Effectively, nobody had anticipated the economic, financial and food crisis of 2007/2008 nor provided a satisfactory explanation for its occurrence and unfolding.
It is therefore necessary to go beyond the “simple” analysis of agricultural fundamentals on the evolution of supply and demand in order to comprehend the many factors that trigger and catalyse volatility.
Among these, growing speculation in agricultural markets undoubtedly plays an important role and therefore deserves special attention in the various economic studies conducted to better understand the new reality of agricultural markets.
We recommend reading this article by Gabriel Omnès1
, deputy editor of the journal Réussir Grandes Cultures (success with large-scale crops), which is particularly instructive on these new approaches to the speculative excesses observed in agricultural markets. Among these approaches, the author of the article quotes Momagri’s chief economist Bertrand Munier.
momagri Editorial Board
Increased liquidity, the main justification for speculation on futures markets, is challenged by some studies. Others question the economic relevance of prices on markets dominated by financial operators.
Can the debate on the financialization of agricultural commodity markets escape the rut? Future research could indeed give new light on the question, which is currently very similar to the chicken and the egg: does the influx of speculators on commodity markets contribute to the price panics of more than five years, or does increased volatility attract these types of operators who cash in on price fluctuations?
The defenders of finance swear hand on heart: speculators do not disrupt the functioning of markets. Don’t the vast majority of academic studies result in the absence of links between speculation and volatility, and even more between speculation and the creation of trends? The only effects that finance would have therefore would be beneficial, starting with the sacrosanct liquidity, brandished as a crucifix to fend off calls for the regulation of financial markets. Liquidity, which ensures trade flow, is effectively essential to the functioning of futures markets. However, the aforementioned are necessary for operators in the physical sector to manage price risks. They also contribute to “price discovery” reflecting the operators' expectations over long periods. Speculation, the daughter of financialization, enables the physical sector to face instability, the joint result of the shocks that undermine the fundamentals and the deregulation of physical markets. QED.
Except that, even within the inner circle of experts, discordant voices are challenging this concept. During the conference organized in Paris in March by Lascaux2
, Bertrand Munier, Chief Economist at the Momagri think tank, challenged the current approach to measuring volatility based on variance. The expert suggests “repairing volatility not with averages, but based on the number of extreme events recorded.” “If the usual measure is used, there has been rather less volatility observed in recent years [coinciding with the rise of financialization, Ed]. But if we measure volatility as I suggest, we note that recent years have seen many more extreme events. However, these are events that generate collapse, are experienced by people in the field, and give them reason against economists.” Under this perspective, current volatility would be placed at a level “not seen in 300 years.” Even more annoying for the financial doxa: for Steve Ohana, a finance professor at ESCP Europe and co-founder of the research firm Riskelia, financial flows are not necessarily providers of liquidity, and can even monopolise it at the expense of market operators in the market for cover. “Do not confuse volume and liquidity, says Steve Ohana.
More volume does not therefore necessarily mean more liquidity”. According to him, the arrival of index investors in commodities markets in the mid-2000s marked a rupture. Previously, financial operators were mostly hedge funds, for the most part because of fundamentals, and generally “trend followers”. Positioning themselves during upward or downward trends, therefore amplifying the trends, but their market knowledge enabled them to jump the bandwagon in the event of excess one way or the other.
GUIDED BY A RISK ON/RISK OFF LOGIC
The colonization of markets by index investors has changed everything. “These players, who in the United States represent a mass in excess of that of Hedge funds have a completely different behaviour”, says Steve Ohana. “They come seeking diversification by investing in the general indexes covering different raw materials such as metals, energy, agricultural products ... By definition, their acquisitions are not driven by the fundamentals of these markets, but follow a risk on/risk off logic.” Risk off corresponds to a configuration of markets marked by mistrust.
These investors then fall back on the dollar, the ultimate safe haven, or on low-risk bonds. On the contrary, in a risk on situation the appetite for risk increases: index flows turn to more adventurous assets such as equities, credit, and now commodities. “This bipolar aspect of markets has a substantial impact on the sphere of raw materials. Prior to 2005, agricultural commodities played the role of safe haven, with a low risk on/risk off correlation. The arrival of index investors has created many connections not only between raw materials themselves, but also with shares, the dollar and other macroeconomic indicators.”
“THEY HAVE NOTHING TO DO HERE”
This indifference vis-à-vis fundamentals is harmful in terms of liquidity, says Steve Ohana: “A liquidity provider must be immersed in the market and know it well in order to understand who requires liquidity, understand if there is tension in sales or purchases... When an index flow appears, the rest of the market has to organise itself to absorb it, the same when it disappears. Unlike hedge funds, these index investors are liquidity consumers.” And Hedge funds, far from mitigating the arrival of these newcomers by taking opposite positions, have started to follow them, amplifying their impact. An analysis shared by Benoît Lallemand, of Finance Watch: “Index investors take liquidity and sit on it for long periods. These people have nothing to do on futures markets. At best they are useless at worst they have a very negative impact, damaging the process of price formation and increasing volatility.”
DISCONNECTION FROM THE FUNDAMENTALS
The critics of the real capacities of this new financial ecosystem to improve liquidity have many questions about its deleterious effects on prices. A model developed by the team of Didier Sornette, a professor of entrepreneurial risks at ETH Zurich, says only about 30% of the price movements recorded on major commodity markets are triggered by information related to fundamentals. The remaining 70% is caused by past price changes in a self-sustaining market mechanism (commonly called “endogenous” events). “These high levels of endogeneity are likely to make the price formation process less efficient,” warns Didier Sornette, who also advanced the “growing instability of the system.”
2 Research project hosted by the University of Nantes, funded by the European Union, aimed at developing a legal approach to food security issues.