Wednesday, May 23, 2007

On agricultural commodity prices

So you've come back from the grocery store, ready to fire up the grill and throw on a few delectable corn cobs with your steak.

The only problem is that you seem to be more hot than your recently turned on grill, and what's got you fired up is rising food prices! Kind of hard to enjoy the bountiful meal you've prepared when you're paying out the nose for it, right?

At times like this, there's only one thing to do: blame the hedge funds!

We've all heard the recent reports of rising food costs across the globe. Media and Wall Street analysts have labeled this trend, "food price inflation", or more recently, "agflation".

But are the higher food and grain prices we're seeing a "driver of inflation" as the news media reports, or a symptom of the higher cost of living we face as true inflation erodes the purchasing power of paper currencies across the globe?

As I wrote in, "Agflation is the new buzzword", the true cause of inflation is being obscured and denied in most media reports, with the blame for "rising prices" being shifted onto the most readily available scapegoats. Supply and demand fundamentals are simply being tossed aside as a primary explanation for rising prices, though their importance in explaining price movements is paramount.

Instead, much of the blame for high prices of food and energy has recently been saddled on speculators and hedge funds. This is not a new phenomenon, and anyone familiar with markets or economic history will attest to that. What is unsettling about this blame game is that it aims to deflect anger over rising prices by dropping the responsibility on someone else's shoulders. This is inaccurate and unfair.

We've certainly heard and seen the reports of traders and speculators gaming the price of energy, metals, and other commodities through the paper futures markets. What remains to be seen is whether these machinations in the trading pits can materially affect prices in the physical commodities over the longer term.

No market participant can direct the long term trend, whether it be up or down; they can only do their best to slow down or accelerate a move. And while powerful traders and speculators may be able to influence or direct price movements in the short term, it's fundamentals that direct long term trends.

So while the experts and media say that supply and demand fundamentals are not a major factor in rising agricultural commodity prices, only to contradict themselves later within the same article, we hope you'll take a moment to consider their arguments and weigh the evidence for yourself.

One last note: higher activity and rising prices in the futures markets could signal more news of shorter food supplies and higher prices to come.

One early bull on commodities in general, and agricultural commodities specifically, is still bullish over the longer term. See Financial News Online US' article, "For Jim Rogers, what goes around comes around", for more.