Global Economics

Speculators Worsening World Food Crisis?


Biofuels and droughts can't fully explain the recent shortages—hedge funds and small investors bear some responsibility for global hunger

Not long ago, Dwight Anderson welcomed reporters with open arms. He liked to entertain them with stories from the world of big money. Anderson is a New York hedge fund manager, and as recently as last October he would talk with enthusiasm about his visits to Malaysian palm-oil plantations and Brazilian grain farms. "You could clearly see how supply was getting tight," he said.

In mid-2006 Anderson was touting the "extraordinary profitability" of field crops from corn to soybeans. He was convinced that rising worldwide hunger would be synonymous with highly profitable—and dead-certain—investment bargains.

In search of new investments, Anderson sends dozens of his employees to visit agricultural regions around the world. Back in New York, at his company's headquarters on the 27th floor of an office building high above Park Avenue, they bet on agricultural markets from Peru to Vietnam.

But in the towers above Manhattan's urban canyons, it's easy to lose touch with the ground. Hedge fund manager John Paulson was recently celebrated for achieving a record annual profit of $3.7 billion (€2.3 billion). Those who work in this environment have only one rule: Don't disappoint profit-hungry investors.

"I'm constantly wired," Anderson used to say, back when he talked to journalists. His nickname in the industry is the "Commodities King," and his Ospraie hedge fund is the world's largest. These days, though, Anderson avoids the media. He's even kept his face out of the media by buying up rights to all photos of himself on the market. His spokesman is now paid, mainly, to say nothing.

A Broken Market?

There are plenty of questions to ask Anderson, though—in particular about the role of international investors in the current spike in the price of staple food. Not only is there talk that investors have profited from desperate hunger in Honduras, the Philippines and Bangladesh; critics also wonder if commodity speculators are making the crisis worse.

On Tuesday in Washington, DC, a regulatory body called the Commodity Futures Trading Commission held public hearings on this very question. Farmers and food producers argued that the market was "broken," suggesting that the steep rise in the price of staple crops was hurting everyone—farmers as well as the people they feed. "The market is broken, it's out of whack," said Billy Dunavant, head of a cotton-producing firm in the United States, at the Tuesday hearing.

Regulators on the commission warned against government intervention, and no doubt fund managers like Anderson would, too. But the crisis keeps deteriorating. India and Vietnam have imposed export bans on ordinary rice. Indonesia is following suit. According to the United Nations, North Korea is on the brink of a humanitarian crisis. After unrest shook countries from Egypt and Uzbekistan to Bangladesh, thousands of South Africans took to the streets of Johannesburg last Thursday to protest high food prices. In Haiti, the prime minister was fired after riots over the price of rice.

Biofuels and global warming have been blamed for shortages driving up the price of food, and both trends have played their role. The planet's grain reserves are almost empty for a number of reasons, including global population growth and greater prosperity in some countries like India. Feed corn is in short supply because industrialized nations have used it for ethanol. Droughts—in Australia, for example—have devastated rice and wheat harvests. Wheat reserves worldwide are only sufficient right now to cover about 60 days of demand.

This helps to explain why commodity prices have rallied since early 2006, with the price of rice ballooning 217 percent, wheat 136 percent, corn 125 percent and soybeans 107 percent.

But classic supply and demand theory offers only a partial explanation. Sudden price hikes since last January have been alarming. The UN estimates that at least $500 million (€312 million) in immediate aid will be needed by May 1 to avoid serious famines. Agricultural scientists at the world body's Educational, Scientific and Cultural Organization (UNESCO) have presented a report on the world food crisis. And criticism is growing that hedge funds, index funds, pension funds and investment banks bear part of the blame.

The History of Futures

Commodity speculation spread long ago from standard products like oil and gold to anything edible and available for trade on the Chicago Futures Exchange. These days there are futures contracts for everything from wheat to oranges to pork bellies. The futures market is a traditional tool for farmers to sell their harvests ahead of time. In a futures contract, quantities, prices and delivery dates are fixed, sometimes even before crops have been planted. Futures contracts allow farmers and grain wholesalers a measure of protection against adverse weather conditions and excessive price fluctuations. They can also help a farmer plan how much to plant for a given year.

But now speculators are taking advantage of this mechanism. They can buy futures contracts for wheat, for example, at a low price, betting that the price will go up. If the price of the grain rises by the agreed delivery date, they profit.

Some experts now believe these investors have taken over the market, buying futures at unprecedented levels and driving up short-term prices. Since last August, this mechanism has led to a doubling in the price of rice—including the 500,000 tons that the Philippine government plans to buy in early May to address its own shortage.

Greg Warner has worked in the grain wholesaling business for more than two decades. His office sits a block away from the Chicago Futures Exchange. He's an analyst with the firm AgResource, and he says what is happening now in the wheat market is unprecedented.

"What we normally have is a predictable group of sellers and buyers—mainly farmers and silo operators," he says. But the landscape has changed since the influx of large index funds. Fund managers seek to maximize their profits using futures contracts, and prices, says Warner, "keep climbing up and up."

He's calculated that financial investors now hold the rights to two complete annual harvests of a type of grain traded in Chicago called "soft red winter wheat."

Wagner is stunned by such developments. He sees them as evidence that capitalism is literally consuming itself.

'It's an Election Year'

Even the Commodity Futures Trading Commission in Washington has recognized the potentially explosive nature of the issue. For Tuesday's hearing, the commission called not just on farmers but also on representatives of investment bank Goldman Sachs and major investors like Pimco and AIG to testify. One member of the commission, Bart Chilton, backed away from regulating investors, saying, "These markets have to work for all the participants. If you don't have speculators in the markets, there's no liquidity and you don't have a market." And the editor of a commodities newsletter, Dennis Gartman, flat-out denied that speculators were to blame.

"It is an election year," he said. "To think you won't have senators and congressmen blaming high prices of things on speculators is naive."

But some basic market rules seem to have stopped working. "The enormous influx of capital has resulted in the futures markets no longer reflecting supply and demand," says Todd Kemp of the US National Grain and Feed Association. Ironically, investors have placed their wildest bets on staple foods. Information about supply bottlenecks and famines at the other end of the world is not noted on market quotations.

A commodities dealer named Christoph Eibl soberly concludes that financial managers just want to "benefit from the scarcity of these commodities." Eibl's Stuttgart-based investment firm, Tiberius, manages €1 billion ($1.6 billion). His in-house experts estimate that hundreds of billions of dollars have flowed into the futures sector as a whole within the last five years, much of it for agricultural commodities. Eibl admits the whole thing demands an "ethical discussion." Some futures traders argue that they don't cause prices to rise in the real world because as a rule they never take delivery of a given crop—other parts of the economy control the actual street price. But futures prices affect real-world behavior (such as inventory hoarding), and Eibl says that buying futures in rice, for example, "eventually causes consumer prices to rise in developing countries like Haiti."

Part 2: 'Passive and Profit-Oriented'

Voices like Eibl's have been rare until now, perhaps because a comparable commodities boom has never existed before. Experts are already discussing what they call a "super cycle," set off by constantly growing demand in China, and by farmers unable, in the long term, to keep up with that demand as they sow their seed and harvest their crops. The planet has only a finite amount of land for farming.

The upshot is that more and more small investors are jumping on the commodities bandwagon. Many investors, not unlike hedge fund managers, seek diversification in their portfolios, partly through investment in agricultural commodities. From the standpoint of these investors, poor harvests that drive up prices are only good for their portfolios. Many investors either don't care or are simply oblivious to the fact that by investing in the global casino, they could be gambling away the daily food supply of the world's poorest people.

Andreas Grünewald is a star among small investors in Germany. He launched his Munich Investment Club (MIC), together with eight fellow students and his grandfather, in 1989 with about €15,000 ($24,000) in initial capital. Grünewald, a business school graduate, now manages more than €50 million ($80 million) for the MIC's 2,500 members.

Commodities are a big issue for Grünewald. "They are the megatrend of the decade," he says. His portfolio in this sector is already worth about €15 million ($24 million). According to Grünewald, this is only the start.

Grünewald says he wants to "remain broadly invested" in water and agricultural commodities, in particular, and "to expand those investments if possible." He has already placed his bets on oranges, sugar and corn on the futures exchanges. His bet on wheat alone has produced a handsome profit of 93 percent to date.

Grünewald has already planned his next step. "Rice is another interesting topic that could complement our portfolio very effectively," he says. Scruples are in short supply in Grünewald's investment club.

"Most of our members tend to be passive and profit-oriented," he admits. At MIC's national events, few people bring up the social consequences of his investment tips. Riots because of exploding rice prices? Aid organizations in a state of high alert? None of this matters much to the preferred suppliers and apostles of profit in the small investor community. The finance industry regularly introduces new investment "products" for every sexy sector, no matter how questionable.

Financial giant ABN Amro has been especially adept at turning a profit in the current market. As a provider of commodities-investment products for private investors, ABN Amro last March became the first bank to offer certificates allowing small investors to place bets on rising rice prices on the Chicago Futures Exchange.

The bank's marketing department has reacted with cold precision to headlines about famine around the world. Two weeks ago, when experts warned of an impending hunger crisis and the political instability associated with it, ABN Amro introduced a new ad campaign on its website. As India imposes a ban on rice exports, the ad said, world rice supplies have declined to a minimum: Now ABN Amro was making it possible, for the first time, to invest in Asia's most important basic food product.

Unveiling an investment product during a supply bottleneck that has since led to riots? Are ABN Amro's bankers really such clichéd, unscrupulous bean counters? "We are aware of the current discussions relating to agricultural commodities," says Önder Ciftci, head of ABN Amro's German certificate business. But he's not interested in a discussion of ethics. "We make the drills, but others have to do the drilling," he says.

ABN Amro has, in fact, drilled into substantial source of profit. In the space of only three weeks, investors raked returns of more than 20 percent. The number of futures contracts traded in Chicago has skyrocketed.

No Food at All?

Jim Rogers, the former business partner of legendary financier and philanthropist George Soros, is perhaps the best-known investor in broad-based commodity funds. He started shifting his money to commodities in the 1990s. On his trips around the world, he came to realize that almost everything, from nickel to cacao, was in short supply in a globalized economy.

He's laid bets on rising prices ever since. This has had an impact on the entire industry, because Rogers' International Commodities Index is a benchmark for countless funds. These moneymaking machines have attracted billions in investments in recent years, and some of that money has been pumped into futures contracts, heating up prices even further.

But now Rogers, of all people, is warning: "Unless something happens soon, we will see people not getting any food at all, at any price. This is the sort of thing we read about in history books, but now I'm afraid that it could happen again."

From his perspective, though, the calamity is not the fault of investors like him, but of developing countries' policies—like imposing export bans and capping prices. This deprives farmers, who face rising costs of necessary items like fuel and fertilizer, of any incentive to produce more rice.

"I think this attitude is morally reprehensible," says Rogers. "These governments would rather let people starve than allow prices to rise naturally." Removing price controls, he says, is the only way to increase rice production levels once again.

Farmers, after all, wouldn't give away their rice to the poor, says Rogers. But he fails to explain how the poor should pay the higher prices in the first place. Perhaps it's up to politicians?


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