What did you have for breakfast this morning? If the answer
is Weetabix, you might be in trouble. Come to that, if you had
eggs on toast, the same applies. Or even a hamburger (the
cornerstone of any nutritious breakfast). And I hope you
didn’t drink orange juice with it. How much did
that set you back?
If you’re wondering, here are some clues. Front
month arabica coffee futures are at $1.76/lb, 41% higher than a
year ago. Live cattle are up 14% on last August, orange juice
40%, cocoa 19%, wheat 41%, lean hogs 75%. At least white sugar
is only up 1% – but in March it was at $750/tonne, 36%
above today’s price.
This is not to say all these prices are at record levels
– they aren’t. But sugar, arabica coffee,
cocoa and pork bellies are all more expensive now than they
have been for the past five years.
And most of the other foods that are widely traded on
futures exchanges had steep price peaks early in 2007 (cattle,
orange juice) or in March 2008 (robusta coffee, wheat) or
June-July 2008 (corn, cattle).
The chances are that if you’re sitting in the
northern hemisphere reading FOi, the price of your breakfast is
not a pressing concern. But think about your last business trip
to Shanghai, Dubai or Mumbai. You’ll have seen
people there for whom 20% and 40% price rises matter
Derivative markets, their participants say, exist to deal
with these risks. They make price volatility more bearable
– perhaps even less severe – for producers
and consumers alike.
But somehow, despite the growth of derivatives trading, that
volatility just won’t go away.
Food prices and agriculture in general, driven from the
headlines in 2008 by the collapse of Lehman Brothers, are back
in the news.
As this article went to press, Ukraine was contemplating a
quota system to cut its exports of wheat from 9.3m tonnes last
year to 1.5m tonnes. Exports of barley, of which Ukraine is the
largest source, could shrink from 6.2m tonnes to 1m. European
barley prices had already jumped 130% in six weeks in response
to the east European drought, before that news.
On the same day, BHP Billiton, synonymous with the hardest
of commodities, offered $39bn for PotashCorp of Canada, the
biggest listed fertiliser maker.
And in its review of the first half of 2010, ETF Securities
wrote: "Agriculture exchange-traded commodities have seen
amongst the steadiest inflows overall since the credit crisis
in late 2008, with net purchases in most of the trading weeks
since the start of 2009." The company ought to know –
it is the largest ETC and commodity ETF provider.
At the beginning of August, Barclays Capital estimated that
commodity assets under management topped $300bn for the first
Three kinds of news: supply disruptions, demand growth and
investment growth. All are bullish for agricultural commodity
But what kind of agricultural derivative markets are
emerging? Are they havens of sanity, where real world risks get
minimised and shared out safely – or a lawless gold
rush for speculative investors – or a maelstrom, in
which fundamental and investment factors wage an endless,
In one way, the excitement about farm produce is no big
deal. Time was, the only contracts traded on exchanges were
corn, wheat and other grains. Perhaps the real surprise is that
it’s taken so long for ags to muscle their way
back to centre stage.
The towering CME Group was originally the Chicago Butter and
Egg Board, spun out from the Chicago Board of Trade in 1898.
The CBoT and Nymex have still more obvious edible roots.
It’s the same in Europe. After the repeal of
protectionist Corn Laws in 1846, regional corn exchanges sprang
up in cities across Britain, as trade bodies sought to bring
transparency to a shady and rampantly speculative forward
These bourses were gradually assimilated into one London
Commodities Market, itself absorbed by Liffe in 1996. Nearly 10
years after the last trading pit closed, the LiffeConnect
platform – catalysed by the Euronext takeover of 2001
– constitutes a vast e-network of European exchanges,
offering hundreds of physical delivery points for the
group’s commodities. Regional trade has been
centralised for good.
"We’ve had a decade of growth, very
consistently year on year, driven by the move to LiffeConnect,"
says Ian Dudden, NYSE Liffe’s head of commodities
(pictured above). "We haven’t looked back
How important are agricultural derivatives to what is above
all a financial futures exchange? Absolutely integral, replies
Dudden – now more than ever.
Rival Eurex joined the fray last summer, listing
cash-settled futures on potatoes, hogs and piglets –
another financial exchange keen not to be left out of the ags
"We’re facing customers who’ve
never traded Eurex products before," says agriculture product
manager Sascha Siegel, his excitement at the prospect
Users are increasingly diverse too, says Dudden, from
investment funds and proprietary traders right the way down the
chain to farming cooperatives, passing through "feed
compounders and flour millers through to starch manufacturers
– and obviously the major merchants and trading
The Midas touch
Therein lie the headlines. Anthony Ward, co-founder of
commodities trading firm Armajaro, had been famous for years in
the cocoa market, but became globally renowned under the
nickname of Chocfinger in July when he took delivery of 241,000
tonnes of cocoa beans, bought with Liffe futures.
This was the largest physical delivery for 14 years (since a
similar, though reportedly loss-making, trade by Ward in 1996).
It equalled 7% of the world’s cocoa supply and may
have helped push cocoa prices to a 33 year high of £2,732
a tonne. Ward is reported to have bought the futures at about
£2,100 to £2,200 a tonne.
No one outside Armajaro knows yet how much money Ward made
on the trade, but if it were as much as £500 a tonne it
could be £120m. Even a quarter of that amount would be a
The manoeuvre prompted angry mutterings from Liffe members
and consumers alike.
"He’s going to have upset a lot of mothers,"
chuckles Gavin Lavelle, CEO of Brady, which provides software
for commodity trading. "But it’s as old as the
hills: taking a big position in the market because you think
prices are going to go up. The fact that someone can take 7% of
the market shows how easy it is to become a major player."
Did Ward do anything wrong? Buying a commodity on an
exchange which sets no position limits because you think the
price is going to rise is perfectly legitimate.
Liffe does, however, practice what it calls rigorous
position management. It has the right to instruct a trader to
reduce or liquidate a position if it sees fit.
On July 27, Liffe released a statement saying: "Today, NYSE
Liffe met a number of its cocoa customers and listened to their
views regarding the cocoa futures market. NYSE Liffe will take
these views into consideration and consult further with its
broader customer base and its regulator before determining
whether any further changes are required to the
market’s operation or procedures."
Whether Liffe did intervene in the market, we may never find
out. But the signs are that it is at least taking market
grumblings seriously – especially those that hint at
moving business elsewhere.
Last year, the bourse finished a long consultative review
with its members on regulatory philosophy, discussing, among
other issues, position limits. No consensus was achieved,
leaving the introduction of stricter position rules any time
What did emerge was a drive for transparency, something many
argue is done better on the other side of the Atlantic. Well
before the 'Big Bang’ of deregulation in 1980s
London, the US Commodity Futures Trading Commission began
publishing its Commitments of Traders reports, giving weekly
updates on the largest long and short positions in commodities.
In fact, the Department of Agriculture’s Grain
Futures Administration started doing this in 1924.
Liffe looks set to try something similar, pre-empting any
move from the newly Bank of England-wrapped Financial Services
Authority (though sources suggest Hector Sants and colleagues
will be given a two year stay of execution, while the Bank
tries to figure out the more serious business of keeping the
Raising margins would be an obvious way to deter anyone from
trying to corner the market – but you can bet not many
of Liffe’s members have been clamouring for
As so often, it’s taken a crisis to drive
agricultural derivatives into the limelight once again.
There’s a reason James Bond author Ian
Fleming never wrote Chocfinger or Soybeans are
Forever. But when Egyptians, Indians or Bangladeshis start
rioting about the price of a loaf, as they did in 2007-8,
people take notice.
This year, Russia’s worst drought since the
1970s, coupled with raging wildfires which have caused hundreds
of premature deaths, are believed to have destroyed up to a
third of Russia’s wheat crop. The government has
banned grain exports until the end of the year –
sending prices spiralling upwards.
Ags traders’ eyes have been glued to Euronext
Paris’s benchmark European Milling Wheat Futures.
The November contract leapt from €135/tonne at the start
of July to €236 a few days after the ban was announced on
The rise in trading volume was still more dramatic
(see graph), a quadrupling of the monthly average to
nearly 600,000 contracts.
US Department of Agriculture figures are still the best
barometer of supply levels, says Jaime Miralles, a wheat
specialist at commodity trading firm FC Stone in Dublin. "There
was real fear and panic spreading in the market about the
Russian wheat crop," he says, "but the USDA have now eased the
bull run on both sides of the Atlantic by putting out a new
forecast, with production cut from 53m tonnes to 45m. The
outlook is more quantifiable now and the last few
days’ trading have been calmer."
"It’s one of the worst droughts
I’ve seen in 30 years," says David Stein,
co-founder of US consultancy the Commodity Weather Group. "The
most comparable I can see is ’75. This is a
once-in-a-few decades event. It’s not only done a
significant amount of damage this season, but also for the
next. They need to start prepping winter grains, which are
important in Russia."
Market participants are already wondering whether Russia
will extend its export ban into next year.
'Keep your eye on the open
How worried should wheat eaters be? Fears of a repeat of the
'Great Grain Robbery’ of 1972 – when the
Soviet Union bought up vast stocks of cheap American wheat
after a terrible harvest – are largely unfounded, says
Prices are nowhere near those days – or even the
last supply and demand scare of 2008, when CBoT prices almost
touched $12 a bushel ($441/tonne).
"There’s never been as much linkage between
global markets as there is now," says Stein. "Now
there’s so much more data sharing. There are
shocks to the market, but they’re much more short
Wheat futures trading has broken volume records –
on Friday August 6, 316,000 CBoT Wheat Futures changed hands,
eclipsing February 27, 2008’s mark of 263,000
– but although prices grazed their limit up levels, at
no stage did the contracts close limit up. For that to happen,
at least two delivery months would have to rise by more than
60¢ in a day, allowing a new maximum rise of 90¢ the
The causes of this price spike seem clear enough –
the drought. But could commodity investors be exacerbating the
problem – blowing a bubble?
Some think so. "Just keep your eye on the open interest in
November NYSE Liffe milling wheat," says Miralles. "That is
telling us much of the story about the European bull run in
wheat. For much of the year, European prices usually follow
those in Chicago. But with new speculative interest in NYSE
Liffe milling wheat these past seven to eight weeks, the
beginning of August was a perfect example of fund money hitting
So, much of the record volumes and open interest in Liffe
wheat futures have been driven by fund buying? "Absolutely,"
says Miralles. "Open interest for November milling wheat was
around 67,000 contracts at the end of June. Since then it has
ballooned to above 130,000. Who is behind that? When one
analyses the use of futures by commercial hedgers and takes
into account anecdotal information, one can make a realistic
assumption that a large percentage is speculative."
So to what extent is price being driven by the raw economics
of speculation: more demand equals higher prices? "One would
like to think it was fairly even [between speculation and
fundamental factors]," Stein reflects. "Say 50-50."
Backing that argument is the correlations observable between
food commodities, even those grown in different parts of the
world. The weather was not bad at once for all the crops that
spiked in 2008. Yes, the oil price played a big part, but there
was no shortage of oil either in 2008 – just a high
price and lots of speculative interest.
And the fundamentals for wheat could yet improve, Miralles
counsels, something which would prick the bubble. "With wheat
prices as high as they are today, what are farmers going to do?
Go out and plant as much as they can." Nothing cures high
prices like high prices, as the old adage goes.
"I would be much more bearish than the market is reacting
right now," he concludes. "The high of €236.00
we’ve reached is, I believe a short term top in
the market. I think €180/tonne is not unreasonable as a
target price as harvest pressure and selling prevail in the
next four to five weeks. Based on short term factors,
I’d call the market here. The longer term outlook
for wheat is less certain and continues to retain a bullish
Should consumers be worried that the weight of speculators
could hide short term changes in fundamental demand until these
become extreme, leading to wilder swings?
Some market attitudes are worryingly blasé. As one
senior figure at a commodity exchange put it recently: "We like
to think of ourselves as a golf course. We provide the
facilities – people come along and play."
Others take a more critical view. "When you get food
speculation, that really impacts people’s lives,"
argues Lavelle. "I’m sure the regulators will have
a look. Do I think we’ll see increased interest
from them? Absolutely. The commodity markets are finite. People
moving into the market is obviously going to have an
Of course, with speculation comes liquidity –
essential to the running of any transparent market.
"What we want to see is liquidity," says Miralles. "This can
be a double-edged sword when one thinks of the current
volatility in prices. However, over the longer term, it will
only add to the benefit of such tools from a risk management
And what goes up can come spectacularly down
– as sugar investors discovered earlier this year
(even Ward appeared to be down £33m on paper the week
after his cocoa trade, as prices dropped 5% in two days).
Raw sugar prices leapt to a 30 year high of 30¢/lb in
March, on poor harvest warnings for India and Thailand. Some
were predicting an annual shortfall of as much as 14.8m
But by the end of March, the rush had turned sour. Barely a
month after peaking, prices had more than halved to 13¢.
Production estimates were moderately scaled upwards –
Brazil, the world’s largest producer, looks set
for a record harvest.
By the middle of August, ICE Futures US’s
benchmark Sugar No 11 Futures (see graph) were back
trading around 19¢/lb.
So, a natural correction of a speculative bubble as the
market came back into line with fundamentals? Toby Cohen, chief
analyst at London sugar merchant Czarnikow (pictured
below), thinks not.
"A lot of comments suggest that some people thought
the rally was a bubble. Those arguments aren’t
true," he says. "Physical demand was there but its impact on
the futures market was overwhelmed as prices fell and investor
positions were liquidated. The size of the resulting order flow
from the physical market is a lot smaller than the order flow
from the investment side when positions are large."
Mass dumping of positions at ever lower prices was to
blame, Cohen argues, as traders became desperate to offload. "I
traded physicals for 10 years. I know how much work goes into
selling 5,000 tonnes of sugar, let alone 50,000 –
especially given the tightening of credit lines. With
hindsight, 13¢/lb was an amazing buying opportunity, but a
lot of people in the market were forecasting single digit
So does he stand by his February statement that the
era of cheap sugar is over? "That’s what
we’re saying," he maintains. "I’m
very much behind that. I don’t see it as a bold
statement. Europe used to subsidise the export of large amounts
of sugar before the reform of the European Sugar Regime. If you
take that subsidised sugar away, the general price level has to
be more remunerative."
Over the past four years, reforms to the EU Common
Agricultural Policy have cut the guaranteed price of sugar by
more than a third. The logical result, Cohen suggests, is a
movement by European farmers into more lucrative crops. Those
deciding what to plant next year will need little encouragement
when looking at the returns on offer in wheat.
So what else is ripe for a spike? "It’s
difficult to pick," says Lavelle. "The hard commodities take
all the headlines, but if you look into non-traditional areas,
you’re seeing much more price volatility. Options
traders love that. The hedge fund market’s waking
up again too. People realise it’s a sector
that’s been under-invested in."
"There’s a lot of interest in rice, in
particular," says Stein. "We get a lot of questions about
commodities that we didn’t in the past. In the
good old days, it was just wheat, corn and soybeans. Now
it’s all about oilseeds."
And judging from the plethora of dairy contracts launched
this year on both sides of the Atlantic, the exchanges are keen
to target other booming sectors too.
On the biofuels front, scare stories about farmers
ploughing their resources into energy crops aren’t
borne out by the facts just yet. Demand for ethanol from
Brazilian sugar has been lower than expected, says Cohen.
"It’s not such a factor in terms of exports this
season. Domestic demand is rising sharply and growth in the
physical market should help the [ethanol] futures contract on
Stein agrees: "I don’t think
there’s significant interest [from developed
He instead touts China as the only circus in town worth
watching as a global leader of prices. "China, in the past five
years, has changed the complexion of the market globally," he
argues. "Before, we had such high wheat reserves, they were an
effective price cap. China was the catalyst for driving
interest in commodities globally."
Cycles upon cycles
Just as with energy and metal commodities, for agricultural
products China is the emblem of the long term bull story. The
world’s population is growing fast and sections of
it are getting richer and consuming more. Production is
unlikely to keep pace with this demand.
There you have it. But the rate of price growth is not
nearly fast enough to wipe out the bumps along the way
– pockets of oversupply that can mean prices dropping
and pain for farmers. As Lavelle puts it, in commodities "there
are massive opportunities for huge corrections. The whole
market could double or halve in a short space of time."
Overlaid on that is long term speculative demand from
commodity 'investors’, eager to ride a long bull
trend. Does this keep prices higher than they should be
– or make them more volatile? If it
doesn’t already, might it do so when commodity
investment funds under management double again?
Some think so, others disagree. What seems a certain bet is
that from producers, consumers and investors, the agricultural
derivative markets are going to keep on getting more and more