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Morningstar: Is food speculation harmful?

In March, Lyxor Asset Management announced its intention to close two exchange-traded products (ETPs) that track agriculture indices, stop allowing new capital into a third, and refrain from creating similar products in the future. Amundi and BNP Paribas have made similar moves in recent months.

Funds that allow investors and speculators to place bets on the price of food-related commodities have come in for considerable criticism for their roles in pushing global food prices to historic levels. In a competition recently created by German MEP Sven Geigold, agriculture funds were named among Europe’s most dangerous financial products.

Derivative contracts, like forwards and futures, tied to the price of commodities have existed for hundreds of years. They were conceived primarily as a way for farmers to protect the value of their crops. But two trends in the past 10 years have made this type of activity much more of an issue today.

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First, the creation of agriculture ETPs and index funds has made the sector easily accessible to a universe of small- and mid-sized investors that would otherwise never have participated in the derivatives market.

Second, developments in portfolio management theory have convinced all types of investors to allocate a portion of their assets to areas like agriculture. As an investment that is expected to act differently than stocks and bonds, agriculture can help diversify a portfolio.

The question is whether these activities have caused global food prices to rise.

An index created by the Food and Agriculture Organisation of the United Nations to track the international prices of a basket of food commodities has more than doubled since 2003. Whether the correlation between that rise and financial investment can also be tied to some degree of causation is being actively debated.

Deutsche Bank, which decided not to close its agriculture funds, found no evidence that financial speculation was driving prices up. Rather, food prices were being pushed higher by such factors as population growth, demographics, and income levels. Moreover, the bank argued that agriculture ETPs were not backed by physical assets, so they may impact futures curves but not spot prices.

But there is data that seems to cast doubt on the bank’s assertions. The food price index has not only gone meaningfully higher, it has also become markedly more volatile. In the period between 1993 and 2008, the food price index’s rolling three-year standard deviation – a measure of volatility – averaged 6.0 per cent a year. Since 2008 it has averaged 12.7 per cent.

There are a number of real market dynamics that have been driving food prices higher around the globe. Specific factors include a shift towards meat consumption in emerging markets, US policy regarding ethanol fuel requirements, and increasingly volatile climate conditions.

It is difficult to establish causation because we haven’t been in this situation for long. But if the potential implication of speculation is turmoil and starvation for the world’s poor, a higher burden of proof should rest on those claiming there is no damage from food speculation.