Wheat prices peaked in March 2008 at $13.34 a bushel, but disparities between cash and futures prices first emerged in 2005. The futures price has since landed above the cash price by as much as $2 a bushel, undermining the market’s value as a hedging tool. High prices were further exacerbated by soaring energy and fertilizer costs and an increased demand for grain from rapidly developing nations such as China and Brazil.
But the report, entitled “Excessive Speculation in the Wheat Market” from the Senate’s Permanent Subcommittee on Investigations, said: “The fundamentals of supply and demand in the cash market alone cannot explain this unprecedented disparity in pricing between the futures and cash markets for the same commodity at the same time.”
It shows an increase in daily outstanding contracts from 30,000 in 2004 to 220,000 by mid-2008 on the Chicago Mercantile Exchange (CME) – the world’s largest wheat futures market.
“We found that index traders purchased huge numbers of wheat contracts on the Chicago exchange, increased futures prices relative to cash prices, and created unwarranted costs and risks for wheat farmers, grain merchants, grain processors, and consumers. It is another case of speculative money overwhelming a market, and federal regulators failing to take the steps needed to protect the market,” said subcommittee chairman Carl Levin, who released the report along with the panel’s Tom Coburn.
Contract limit exemptions
The CFTC (Chicago Futures Trading Commission) – the body charged with preventing excessive futures market speculation – has issued several exemptions for futures traders since 2005, allowing dealers to hold more than the 6,500-contract limit. The report said that these exemptions have allowed six index traders to hold almost 130,000 wheat futures contracts at one time – or about 60 percent of all outstanding wheat contracts held by index traders.
To combat excessive speculation, it recommends phasing out the waivers that allow traders to exceed the 6,500 wheat contract limit, to consider further restrictions, and to analyze and strengthen other commodity data.
Levin said: “The bottom line is that excessive speculation in commodity indexes has created losers throughout the wheat industry, from wheat farmers to grain elevators, grain merchants, grain processors, and grain users like bakeries and cereal companies. Those groups can’t manage their price risks through hedging, and are socked with unwarranted costs from higher margin calls and failed hedges. When those costs are passed onto consumers, the result is higher food prices.”
However, the CME has disagreed with the report's findings and said in a statement: "The Subcommittee Report is contradicted by four separate studies conducted by The Commodity Futures Trading Commission ("CFTC"), the Government Accountability Office ("GAO"), Informa Economics Inc. ("Informa") and CME Group - all of which concluded that there is no causality between market participation of index funds and non-commercial traders and wheat price levels or cash market convergence at expiration."
Speculation on the futures market can perform an important function, helping the price discovery mechanism by highlighting any emerging imbalances between supply and demand – in this case, encouraging planting when supply is tight and prices are high and discouraging it when supply is good and prices are low.
In April, a University of Illinois study suggested that the market could lose its relevance if cash and futures price gaps are not reduced.
A subcommittee hearing on excessive speculation in the wheat market is due to take place in July.