The activity of financial speculators is overwhelming agricultural commodities markets, fuelling global food price inflation and hunger, according to new analysis from the anti-poverty group the World Development Movement (WDM).
Its report, Broken Markets, published on Tuesday, finds that financial speculators with no interest in the physical goods traded now dominate agricultural commodity markets. WDM's report coincides with news that food inflation in the UK was running at 6.2% (pdf) in August. Annual inflation on bread and cereals was even higher, at 7.1%, compared to headline inflation of 4.5%, according to figures just released by the Office for National Statistics.
WDM says the spiralling food prices are being driven by financial players taking over commodities markets. Those on low wages in the UK and the poorest in developing countries are hit hardest, since they spend a larger proportion of their income on food.
Financial speculators now account for more than 60% of some agricultural futures and options markets, compared to just 12% 15 years ago, the development group says. Those with direct commercial interests in food production used to be the main participants, but now hold less than 40% of the market compared with 88% in 1996. The result is that agricultural markets no longer respond to underlying fundamentals of supply and demand and fail to provide producers with an effective way to hedge their risks.
"Financial speculators have flooded food commodity markets, creating massive inflation and sudden price spikes. These broken markets are bad news for people in the UK, whose average annual food bills increased by £260 in one year alone. But for people in poverty in developing countries, price rises are disastrous," the report's author, Murray Worthy, said. WDM is calling for the UK government to stop blocking proposals in Europe to reform the markets.
The role of excessive financial speculation in the recent sharp rises in food prices has been controversial. The commodities exchanges and some analysts have argued that price rises and swings are the result of increasing demand and tightening supply. Christian Aid (pdf) and Oxfam have, however, also pointed to a huge rise in speculative flows as one cause of the global food crisis.
The WDM report identifies several types of investment made possible by deregulation in the past decade, each of which it believes is distorting the markets:
• Commodity index funds, which allow institutions such as pension funds to bet against movements in commodity prices. These funds are "long only", which means they only take positions speculating that prices will rise and they "roll" their positions, replacing contracts each month to maintain the same position in the market. These "massive passives" do not respond to the underlying fundamentals of supply and demand and so distort agricultural markets, WDM says.
• Computerised high-frequency trading is adding to the volatility of prices and has led to "flash crashes" in the sugar and cocoa markets. In this kind of trading, past price movements are analysed and used for algorithmic trading for very short periods of time. For example, when prices of sugar and cocoa started to fall in late 2010 and early 2011 respectively, they triggered the computerised models to sell automatically, fuelling a downward spiral that saw sugar fall by 11% and cocoa by 12.5% in a single day.
• Commodities exchanges now make their profit from the numbers of trades made, meaning they have a strong incentive to promote greater volumes of these sorts of speculative activities.
• Over-the-counter trading, which takes place outside the regulated exchanges, has boomed. At present, only commodity futures and some options are traded on exchanges. The rest of the derivatives market is traded through unregulated bilateral deals between institutions such as banks and pension funds. Over-the-counter trading bypasses the requirement on the exchanges for traders to post margins, ie put up a sum of money to cover the risk they are taking on any contract. This absence of transparent risk management creates dangerous bubbles, according to WDM.
In the past five years, the total assets of financial speculators in these markets have nearly doubled, from $65bn in 2006 to $126bn in 2011.
The largest contributions to food price inflation in the UK came from bread and cereals, meat (for which prices rose by 7.1% over the 12 months to August), mineral waters, soft drinks and juices (with a 9.4% rise), and sugar, jam, syrups, chocolate and confectionery, for which prices rose by 7.6%.