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Tom Holland

Five years ago the South China Morning Post had what diplomats like to call a robust exchange of views with veteran investor Jim Rogers.  
Rogers was expounding his now familiar view that commodities were at the beginning of a long-term bull market and that investors should fill their boots if they wanted to earn superior returns.
Hold on, queried the Post, was there not a risk that a large influx of investment capital into commodity futures markets could severely distort prices, amplifying volatility and possibly inflating a momentum-driven bubble?
Not at all, replied Rogers, explaining that the value of financial investments in commodity futures was so small compared to the hedging positions of suppliers and users that the activities of purely financial investors could have no material influence on prices.
But, asked the Post, in a market like oil where underlying supply and demand are tightly balanced, surely a relatively small inflow of speculative funds at the margin can have a disproportionately large impact on prices.
Nonsense, Rogers retorted. 'Speculators are not causing the price of oil to go up.'
Five years on, and one boom and bust later, no one seriously doubts any more that purely financial participants in the futures markets have an enormous influence on the real-world prices of the underlying commodities.
Just look at the cocoa market. At the weekend it was widely reported that a London-based hedge fund manager - instantly dubbed 'Chocfinger'  - had attempted to corner the European cocoa market. He used futures contracts to take delivery of 240,000 tonnes of beans - said to be enough for more than five billion bars of chocolate - driving the cocoa price to its highest level in more than 30 years (see the first chart below).
The story was reported in a jocular, silly-season, style, but not everyone is amused by the influence of financial players on commodity prices.
Last week a UK-based anti-poverty lobby group called the World Development Movement accused investors in commodity index products of pushing up food prices and driving tens of millions of people around the world deeper into poverty and hunger. The organisation named a clutch of the world's largest banks as the main culprits, accusing them of exacerbating illness and malnutrition in developing countries, and even of forcing vulnerable women into prostitution.
Although its accusations sound slightly hysterical, the lobby group does have a point. In the past, financial speculators in the futures markets have defended their activities by arguing that futures trading is a zero sum game where buyers are matched by sellers with no influence on the underlying price.
But that defence supposes that price signals in the futures markets never prompt anyone to stockpile physical commodities, and that financial players never actually take delivery; a supposition that Chocfinger has clearly disproved.
The experience of recent years - the massive flow of investment funds into commodity markets in 2008 and the resulting bubble - demonstrates that speculation can indeed drive underlying prices up, with painful consequences for the world's poor.
Unfortunately the solutions suggested by the World Development Movement - that over-the-counter derivatives on food products should be banned and caps imposed on banks' exposure - aren't unlikely to help much.
Much of the investment in agricultural commodities is channelled through regulated exchanges anyway, so banning OTC contracts would merely deny end-users access to tailor-made hedges. Similarly, slapping limits on banks' trading books could restrict their ability to structure hedges for their clients.
It might be hoped that market forces will help solve the problem. Although according to Barclays Capital  financial assets invested in commodities have soared to a record US$292 billion recently, much of the inflow has been into gold-based products. Assets under management in agricultural products have fallen recently (see the second chart).
That could just indicate that the experience of 2008 has convinced institutions that pouring money into agricultural futures risks creating dangerous bubbles which then inflict punishing losses when they inevitably burst.
But that's probably too optimistic. After all, both Rogers and 'Chocfinger' are still bullish on agricultural commodities, and investors have a poor record of learning from experience. Expect higher food prices.



'Chocfinger' and friends are bad news for the world's poor