Market Matters Blog

Time to End the Unicorn Hunt

By  Katie Micik

It’s time to end the grand unicorn hunt for the mythical bubble-causing investor, University of Illinois ag economist Scott Irwin told the USDA Ag Outlook Forum. The misperception that index funds and other noncommercial traders caused the run-up of commodity prices in 2008 and 2011 is easy to dispel when you look at open interest and price relationships.

So what gives?

Irwin said that most Americans like linear, straight-line relationships. And storable commodity price relationships are anything but linear. This summer, for instance, a 13% change in U.S. production generated a 29% change in stocks and created a price change of 250%, according to Cargill AgHorizon president David Baudler. Farmers and economists know that grain storage creates a cushion, and when stocks are low price reactions are magnified.

“When you have a large amount of stocks on hand, a given reduction somewhere in the world doesn’t cause a huge spike because stocks are a shock absorber,” Irwin said. “But if you’ve been drawing down stocks, like we have for a few years now, you get in a situation where the shock absorbers are no longer available. You have to convince you and I to reduce our current use.”

Focus on the mythical bubble investors distracts from the real question that should be asked: How well are the markets doing at price discovery?

“We’ve witnessed more structural changes in the last decade, I’d argue, than in the previous 150 years combined,” Irwin said. He rattled off a list of the big ones: the shift to electronic trading, online discount brokerages, index investment, ETFs, high frequency trading, real time release of government reports.

On average, the markets are doing a more efficient job at price discovery, Irwin said. But there are some real bumps in the road ahead, and he cautioned that new rules and regulations on the market need to be evaluated carefully. 

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Comments

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Jarrod Collins
2/25/2013 | 1:52 PM CST
Katie this is such a long discussion with soo many point of views and questions I have on this subject. The only conclusion I can come up with is that we further discuss this subject over a steak and a beer!! Lol
THOMAS FARLEY
2/25/2013 | 10:02 AM CST
While John's reaction above was my initial interpretation, I have to admit that there hasn't been great evidence for blaming higher prices and/or volatility on either passive index investors or active money managers. In the case of grains there are too many factors to be sure of the impact of any one factor--the enormous growth of ethanol use has come at the same time as the growth in commodity index investing. Further, we should see higher prices and volatility in many or all commodities if speculation is the most important factor. But where is the rise in hog or cattle prices?
KATIE MICIK
2/24/2013 | 5:30 PM CST
Yes, John, what a wonderful comment. Here's a link to Irwin's presentation. I don't think anyone would doubt that increased speculative trading is one of the massive structural changes in the market place. But I think Irwin's point was that a confluence of factors contributed to the big prices spikes. If, for instance, speculative traders caused the wheat price run-up 2008, their open interest volume should have been increasing. In reality, it had been in a sideways trend for two years prior (you can see the chart in Irwin's presentation). There also was a vein of conversation at this forum about the combination of factors that might turn investors away from agricultural commodities -- and there are some that think that could be sooner than later. I'd suggest watching the video of the presentation and the Q&A afterwards. http://www.usda.gov/oce/forum/index.htm
Dale Jenkins
2/24/2013 | 12:22 PM CST
Wow, excellent Comment!!
John Posthuma
2/22/2013 | 10:53 AM CST
Well if anyone believes that investor trading has no impact on the markets I got a bridge I can sell them. First, the term investor trader is false. They are not investing in anything. They are speculating, at no time do they plan on producing or using the commodity. If they invested they would have corn in a bin somewhere and would have paid full price for it. They are purely working on margin and have the ability to influence large amounts of a commodity with little capital. Their best strategy is to instill fear, greed and then panic in any given commodity. They then can react quickly and influence a very volitile market causing commercial buyers and sellers to overreact. Just look at the limit moves back and forth that we have seen in the last five years. That is not from normal demand/supply trading. You can call this "price discovery". I call it price gouging. Sure they are assuming "risk" but every time they can take money out of the middle, it is from the hands of the producer or end user, and that causes someone else loss which has to be followed sooner or later by inflation.