Wall street farmers

In "Nature's Metropolis: Chicago and the Great West" (highly recommended) historian William Cronon describes how the Chicago Board of Trade revolutionized the exchange of grain by turning the physical crop into an abstract commodity that could be easily traded amongst merchants, traders and farmers. Futures trading changed farming and the American landscape forever.

News that Wall Street has renewed its interest in agriculture commodities is not surprising -- particularly given how agribusiness has transformed food production in the U.S. But for those committed to the goals of sustainable agriculture (building strong, healthy relationships between the Earth, farmers and consumers), the fear is that investors are far more interested in agriculture futures than the future of agriculture. (GW)

Wall Street Is Betting on the Farm

By Alexei Barrionuevo and Jenny Anderson
New York Times
January 18, 2007

CHICAGO, Jan. 18 — Wall Street commodity funds that have been investing heavily in energy futures are now loading up on agricultural commodities like corn and livestock futures.

The flood of investment has raised concerns among grain traders and agricultural producers that speculative money is gaining an undue influence over their markets, which help set the prices of raw commodities for a host of consumer food products.

A recent study by the Commodity Futures Trading Commission, which oversees the nation’s futures markets, has found that Wall Street commodities index funds — investments in futures that track the underlying commodities of a particular index — have a much heavier concentration in agriculture futures markets than many had expected.

The commission found the Wall Street funds control a fifth to a half of the futures contracts for commodities like corn, wheat and live cattle on Chicago, Kansas City and New York exchanges. On the Chicago exchanges, for example, the funds make up 47 percent of long-term contracts for live hog futures, 40 percent in wheat, 36 percent in live cattle and 21 percent in corn.

“These are jaw-dropping numbers,” said Dan Basse, president of AgResources, an agricultural research firm in Chicago. “We have seen this explosion of open interest in agricultural commodity trading, and now we know it is largely related to the commodity index funds.”

The index funds may be stoking volatility, traders and analysts say, because the agricultural markets tend to be far less liquid than other commodity markets, like energy. Such volatility could lead to higher prices for buyers and sellers of agricultural commodities, including food at the grocery store.

Investors have flocked to invest in commodities, drawn to an alternative to stocks and one whose returns in the last five years have been outstanding. Industry analysts estimate the index commodity market is about $100 billion to $110 billion, up from $80 billion in 2005.

The market leaders are Goldman Sachs, with its Goldman Sachs commodities index, estimated to be about $60 billion at the end of 2005, and the Dow Jones-AIG commodity index, estimated at $30 billion to $40 billion. About 20 percent of the Goldman Sachs index, which has a heavy emphasis in energy, is weighted in agriculture and livestock commodities. About 40 percent of the Dow Jones-AIG index is in agriculture and livestock.

New players have joined the market, including the restart of the CRB index in 2005, via a joint venture of Jefferies bank and Reuters.

“Demand is considerable,” said Eliot Geller, a managing director at Jefferies who is on the oversight committee for the CRB Reuters-Jefferies index.

Commodities experts also chalk up the recent surge in demand to investors looking to diversify their portfolios.

“As baby boomers approach retirement they are becoming more focused on securing that retirement nest egg and they are certainly looking for higher-return strategies,” said John Brynjolfsson, portfolio manager for Pimco’s Commodity RealReturn Strategy, a $12.1 billion mutual fund. “But the crash of 2000 made them aware that risk management is as big a part of investing as searching for returns, and that’s where commodities fit in.”

The increased trading volume of commodities indexes, which has been building over the last three years, is generally good for giving buyers and sellers a more secure place to trade contracts and for smoothing out big price swings.

But many in the agriculture industry say that the index funds are increasing volatility, widening the spread between low and high bets on future prices, not only because of their sheer size but because the funds have tended to move in herds in response to market signals.

Because the funds are prohibited from actually owning physical commodities, they “roll” their futures contracts each month, often helping make the prices for commodities in future months higher. And each year the funds rebalance their portfolios in Robin Hood-like fashion, taking profits from commodities that have risen in price and reinvesting them in other, lower-priced commodities. The goal is to keep the commodities in the baskets at certain weighted percentages.

The volatility, intensified by the index funds, could ultimately raise food prices for consumers, several economists and analysts said.

“The cost from the farm to the grocer is elevated because of the volatility from these funds,” Mr. Basse of AgResources said. “It will raise the cost for everybody, including the consumer.”

The new data about the index funds’ participation in agricultural markets comes at a time when the prices for corn, wheat and other grains are at record highs. There are market-related explanations for the price run-ups: The growing demand for ethanol as a transportation fuel has pushed up corn prices to their highest prices in a decade, and ethanol demand and world droughts have combined to lift wheat prices to their highest prices in a decade as well.

The index funds could be one more factor influencing grain prices, analysts said. Volatility in the corn markets has caused the Chicago Board of Trade to increase the risk capital required to buy or sell corn futures. Last week the deposit required to trade was elevated to $1,215 a contract, up from $338 last January.

Livestock prices have also been relatively high, driven by high prices for corn and soybeans, the principal feeds for cattle, chickens and hogs. The livestock markets are significantly less liquid than grain markets, making them more vulnerable to influence from the large index funds, analysts said.

“Everybody is scrambling to understand the implications of the funds’ presence in the market on our ability to manage our risks,” said Gregg Doud, the chief economist at the National Cattlemen’s Beef Association.

Mr. Doud said the concern of livestock producers was that the index funds tended to all “head through the door at once.” He said he shuddered at the thought of another major market shock like the one in December 2003, when a cow was discovered in Washington to have the virus that causes mad cow disease. Within a few days, live cattle prices dropped by 16 percent.

“If that would have triggered a signal to head for the exit, would the index funds have exacerbated a serious situation by virtue of how big they were?” Mr. Doud said. “There was nobody big enough to stand on the other side.”

Concerns began to mount last year among grain traders and live cattle producers that the index funds were being lumped into a commercial category of market participants that trade physical commodities. The Commodity Futures Trading Commission had previously concluded that the index funds were doing legitimate financial hedging, even though they were barred from trading physical commodities because of concerns that that they could corner the market. Mr. Doud from the cattlemen’s association, and others, argued that the market needed to understand who was hedging physical commodities and who was hedging financial contracts.

When the commission asked for input on the data it was providing, more than 4,600 comments poured in, a record number, said John Fenton, the commission’s deputy director for market surveillance.

“Index trading is primarily to diversify a portfolio,” Mr. Fenton said. “A long position as a result of that trading would potentially send a different message to markets.”

The commission ended up separating out the index funds into a separate category. It published the first report on Jan. 8 and also released a year’s worth of historical data. The commission said it would produce the weekly breakdowns for at least the next two years.

Alexei Barrionuevo reported from Chicago and Jenny Anderson from New York.