The Spec Effect

Lately, it seems the volatility of commodity markets has been blamed on everything from the federal biofuels program to inflation. But are these the root causes of the price appreciation experienced by grains over the past three years, or is the real culprit a bit more inconspicuous? Let us examine what we have come to refer to as “The Spec Effect.”

 

Speculators are welcomed in grain markets and seen as a necessity to create volatility. Commercial users of grain are sometimes heavily situated on one side of the market—long or short—depending on the time of the crop year. During harvest, for instance, soybean crushers tend to be positioned short on grain futures due to the need to hedge soybean purchases. For as long as grain has been traded on an exchange, a small group of speculators provided volatility with long contract purchases and the desire to “play” the markets based on fundamental factors.

 

In the last few years, the market has experienced an influx of managed money by way of index funds, creating a relatively new dynamic in grain trading. The effect of this phenomenon is a matter of numbers; the more money a speculator invests in a market, the greater his ability to impact price direction. Biofuels came into play indirectly. As the speculative interest in grain commodity markets grew (especially in corn, soybean, and soybean oil futures), commodities previously being used for food and feed production were now in demand for ethanol and biodiesel production. The trend continues today as grain futures establish higher price floors than those seen prior to 2006.

 

So what does all this mean? In order to fully understand commodity market dynamics, one must also consider the effect of speculative dollars on commodities—perhaps in spite of the fundamentals. Please email or call (510) 832-2866 for additional information.