I May Be Paranoid But That Doesn’t Mean Someone Isn’t Following Me

In a development that is likely to have some impact on the food industry, the U.S. Senate Permanent Subcommittee on Investigations has released a report that accuses commodity index funds of making large purchases of wheat futures it described as “excessive speculation” resulting in “significant unwarranted costs and price risks.”

Consumers, retailers, foodservice operators and CPG houses have all decried the sharp jump in commodity costs last year, with the subsequent squeeze on prices and margins. All sides pointed fingers at the others in claiming “price gouging,” even as all sides insisted they were only passing along partially their rising costs. Senator Carl Levin of Michigan is chairman of the subcommittee whose 247-page report is entitled bluntly Excessive Speculation in the Wheat Market.

The senator said that “In the last three years, speculators have spent billions of dollars on commodity indexes, and the financial firms selling those index instruments have purchased billions of dollars in commodity futures to offset their financial risks, creating price disruptions for producers and consumers.” The subcommittee examined trading records from the Chicago Board of Trade (now part of the Chicago Mercantile Exchange), the Kansas City Board of Trade, the Minneapolis Grain Exchange, the Commodity Futures Trading Commission (C.F.T.C.) and others to track the rise and fall of wheat prices.

Commodity index traders increased their holdings from about 30K wheat contracts in 2004 to 220K by 2008. By 2006, commodity index traders held 35%-50% of all outstanding wheat futures contracts on the Chicago exchange alone. The practical result of this activity was the average basis (the gap between futures and cash prices at a given location) at contract expiration grew from about 13¢ per bushel in 2005 to 34¢ in 2006, 60¢ in 2007, all the way to $1.53 by 2008, a 10x increase in just four years.

These “unwarranted” increases “imposed undue burden on those involved all along the wheat marketing chain, from producer to consumer.” Costs included higher margin calls due to higher futures prices, failed hedges and disruption of normal pricing patterns and relationships according to the report. The report also criticized the C.F.T.C. for waiving position limits for commodity index traders which “facilitated excessive speculation in the Chicago wheat futures market” and was “inconsistent with the C.F.T.C.’s statutory mandate to maintain position limits to prevent excessive speculation.”

The subcommittee, in a move sure to stir opposition from the financial community, is recommending the C.F.T.C. drop existing waivers and reapply standard position limits, potentially imposing other measures if that doesn’t solve the problem.

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