commodities futures

This, “How Goldman Sachs Created the Food Crisis” is already Frederick Kaufman’s third article on the subject in as many years. As the article indicates, here “Goldman Sachs” just stands for the financial speculators in general. He is milking this thesis a bit dry at this point — but he has a point, sort of.

There are those who argue that financial speculators, for their own good, closely track underlying supply and demand, and therefore stabilize — not destabilize — markets. But this is not the case. Experiments have shown that, even for an instrument with a perfectly known valuation, the existence of human players itself creates speculative intent which can at least temporarily unanchor market prices. Speculation itself certainly doesn’t stabilize markets, in fact it has to be disequilibriating — required for price discovery. What keeps prices stable are well structured instruments that anchor to real economic variables by some other mechanism, things like periodic reconciliation of contracts, payment of agreed-upon dividends, or taking delivery of commodities. Anything that needs no reconciliation for an indefinite period of time is asking for trouble.

And this is the case with automatically rolled commodities futures embedded in commodities funds. Besides the fact that these funds are only really useful during price shocks (and not during predictably rising and falling prices, which would be priced into the futures contracts already), this effective lengthening of contract duration must by itself unanchor market prices. It must. This is beyond the fact of the so-called “long-only” issue from the initial demand creation, which indeed causes a demand shock. But even after the new demand stabilizes, commodities prices can be expected to be still more volatile than before these funds were created.

It isn’t all for nothing though. The commodities market now sees “farther” into the future in terms of supply and demand. As a commenter said, people are buying commodities funds with the view that there will be future supply shortages, so they are sending price signals for producers to ramp up now. So the benefit is ostensibly that we starve less in the future, at the cost of starving more people today. Perhaps we can argue whether the former part is worth more volatility, but still the latter part isn’t strictly necessary. As with many such things, the speed at which capital is allocated is the issue. It is only a demand shock when funds flow faster than farmers can respond and plant more crops. More volatility is arguably good for speculation, as it implies larger price amplitudes, shorter time-scales for profit, and more arbitrage opportunities; it just isn’t necessarily beneficial to the real economy.

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