Senate Report Finds Excessive Speculation in Wheat Markets

• June 28, 2009
• Paul Neiffer

A Senate Subcommitee spent the past year investigating the impact of index funds on the wheat market.  They concluded that all of this new money flooding into index funds distorted the market.  The 247 page report released on June 24, 2009 summarized their findings as follows:

1.  Excessive speculation in wheat.

• Index Traders increased future prices relative to cash prices.  The large number of wheat futures contracts was a major contributing factor in the increasing difference between futures and cash prices between 2006 and 2008.  Largely as a result of index trading, the basis difference between cash and futures rose from 13 cents per bushel in 2004, to 34 cents in 2006, 60 cents in 2007 and $1.53 in 2008, an approximate 10 fold increase in four years.
• Index traders impeded price convergence at expiration.  Normally the futures price and cash price should converge to an approximate difference of zero at expriration.  The index traders created a frequent failure of the markets to converge.

2.  Inflated futures prices affect crop insurance.  Because federal crop insurance, which is backed by taxpayers dollars, use futures prices in its calculations, inflated futures prices can inflate insurance premiums, whose costs is shared by farmers and taxpayers, and impair the accuracy of the formulas used to determine the payouts to farmers, resulting in either overpayments or underpayments.

3.  CFTC waivers facilitated excessive speculation.  The report indicated that certain funds were allowed to have up to 53,000 contracts at a time.  This represents about 265 million bushels of wheat which would equate to over 10% of the total US crop.  Six funds are allowed to hold up to 130,000 contracts equalling 650 million bushels.

4.  Poor data impedes analysis. 

The report found four recommendations:

1.  Phase out existing wheat waivers for indes traders.

2.  Take further action if necessary.

3.  Analyze other agriculural commodities.

4.  Strengthen data collection for non-agriculatural commidities.

My opinion on these findings is that it is easy to blame these index funds for causing the excessive speculation in wheat prices, however, they do not really address whether this is actually a bad thing. 

The crop insurance issue can be addressed by changing from future prices to various cash markets around the country. 

Also, these index funds do provide liquidity in the market that would not otherwise be there.  I also believe that a lot of elevators were hedging their purchases using futures and the diveregence of the futures to cash prices probably did have a huge effect on them.

You can read the 21 page executive summary of the report.

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