This weekend I noticed another story about speculation in commodities, this time in cocoa. Since the commodity markets don’t get nearly enough attention, or enough outrage in my opinion, I’ve posted this story alongside an earlier one that explains how commodity markets work.
The latest speculation debacle is in the cocoa market, where the prices of cocoa have soared by 150% in the last year and a half. This is partly because of a crop failure in the world’s largest producer, Ivory Coast. The threat of a shortage was then exacerbated by an unknown speculator buying hundreds of millions of pounds worth of futures contracts, essentially betting that there wouldn’t be enough to go around. Sure enough, the price has of cocoa risen to a 30 year high of £2,950 a tonne. For chocolatiers and confectioners, people who actually need to buy the stuff, this is a serious blow to their profit margins.
To buy something you don’t want in order to boost the price so that you can sell it on to those who need it is an abuse of the market. It’s remarkable that it’s legal, and of course this is just chocolate. When the same thing happens with corn or rice, the result is starvation. Speculation on commodities is one of the most obvious ways in which financial services are profitable, but hugely destructive to other business. It’s an unproductive business that destroys productive ones.
A confederation of cocoa buyers has taken the rare step of writing to the London International Financial Futures Exchange to complain about the state of the cocoa market. If the speculation continues at the expense of those who need the markets to run their businesses, they will leave London altogether. “From the moment a market becomes purely a vehicle for speculation,” they write, “it loses its usefulness.”
There is an urgent need to address unproductive speculation in essential commodities, particularly staple foods, and of course oil. It’s a dog-in-the-manger investment model that will only prove to be more destructive as global demand for resources rises, especially if oil and metals and other resource stocks begin to decline.
The Earthbound Report 
Derivatives were originally designed to act as economic risk mitigation tools (which is why they’re legal), but as we see these days, they’re often misused. And it simply goes to underscore Warren Buffet’s opinion that “derivatives are financial weapons of mass destruction”. Since the market is comparatively young, we ought to see some sort of restriction on speculative trading in the future, perhaps similar to the Robin Hood Tax.
I think it is too easy to enter the commodity markets. They are very different from stock markets, as shares are not real things. As an example, BP has supposedly lost a third of its value this year, but it remains exactly the same size as a company – all that value is imaginary.
Speculators forget that dealing in commodities means real things, real needs, and people going without. To the trader, it’s just another computer screen and a bunch of numbers. It’s meaningless to them, and all the consequences fall on manufacturers that rely on the actual goods traded, and of course on the consumer. It’s a predatory form of investment.
So Robin Hood style taxes are great for stock markets, but I’d like to see much tighter controls on who is allowed to trade in commodities in the first place!
Good comment Jeremy. A financial transaction tax would be very useful for many reasons. But for commodity markets stronger action is needed to prevent excessive speculation. This means tight limits on the amount of speculation. A little bit of speculation may be justified as it is needed to provide ‘liquidity’ to those such as farmers who are using derivatives for a useful purpose. But not teh huge amounts of money which is currently swamping food markets. Over the next few days the US Congress should pass legislation to empower new limits on speculation. But nothing of the sort is happening in the UK yet. We need to make it. You can join the campaign here http://www.wdm.org.uk/food-speculation