Is speculation behind wheat price rise?

In May 2007, the Centre banned wheat futures trading after prices surged in the open market when production turned out to be lower than expected.

Output then was 75.81 million tonnes against initial projections of about 80 million tonnes. The lower production also led to procurement by Government agencies for buffer stocks plunging to 11.12 million tonnes (mt).

Prices then rose to ₹1,000 a quintal in the open market, forcing the Centre to blame the increase on the futures trading and subsequently ban it.

The then National Commodities and Derivatives Exchange chief PH Ravishankar said that the rise was not surprising since the futures market had been pointing to such a trend from 2006-end.

Opposing the ban, he had said that the Government had failed to take note of an alert by the exchange.

In short, his argument was that wheat prices increased on demand-supply fundamentals and futures trading had little to do with food inflation.

Seven years later, a study by the Economic Research Service by the US Department of Agriculture upholds his argument, saying that rise in wheat prices is due to demand-supply shocks and has little relation to speculation.

The study, which took into account the wheat price spike in 2008 specifically, says that movements on the three US commodity futures exchanges in the US were fundamentally driven and associated with shocks to supplies.

“Supply-and-demand shocks specific to the wheat market were the dominant cause of price spikes between 1991 and 2011 in the three US wheat futures markets (hard red winter, hard red spring, and soft red winter wheat),” it said.

In the study “Deconstructing wheat price spikes: A model of supply and demand, financial speculation, and commodity price movement”, Joseph P Janzen, Colin A Carter, Aaron D Smith and Michael K Adjemian, looked into how wheat prices rose and then subsequently dropped in 2008 along with other agricultural commodities.

Focusing on the wheat price surge in February 2008, the study said that had there been no supply-demand shock, including weather developments that lowered crop yields, prices would have been 40-62 per cent lower.

On the other hand, had there been no report of demand-supply shock or projection of carryover stocks, prices could have been lower by 11 to 36 per cent.

In February 2008, wheat prices on Minneapolis Grain Exchange soared to $24 a bushel from $8.

The study says its findings suggest that wheat futures have performed efficiently, reflecting fundamental factors. Therefore, any curb on speculators is unlikely to prevent price spikes.

The study said long-run trends in wheat production could be anticipated. Therefore, wheat prices remain volatile because of production variability in the short-term. Weather, pests, and disease drive much of the variation in wheat yield, and their effects are difficult to anticipate, so prices adjust in response to quantity shocks. Both the US and world wheat supply vary considerably from year to year.

Production in a single country such as the US is more volatile than overall production worldwide. In the US, planted acreage is particularly variable relative to yield. Globally, acreage and yield exhibit similar levels of year-to-year variation. Variability in acreage mainly reflects opportunities for substitution in production between wheat and other crops but also the potential for new land to be brought into production.

The study eased a structural vector autoregression econometric model to decompose observed wheat prices into a set of factors and to explain the relative contribution of each factor to observed price changes.

The factors included real economic activity affecting demand for all commodities; passive or financial speculation by commodity index traders based on a desire to hold baskets of commodities as part of a larger investment portfolio; precautionary speculation related to expected prices in future periods and the incentive to hold wheat inventories and the respective crop-year supply and demand shocks specific to the wheat market.

Unlike studies of other commodity markets using a similar approach, this report found that broad trends in global commodity mattered less to wheat price determination than do its own supply-and-demand factors. This could be due to the nature of wheat as a staple cereal grain. While global wheat production and consumption is growing, per capita demand growth is decelerating even in the developing world.

Emerging economies may not be as hungry for wheat as they are for industrial commodities, it said.