What Role Does Speculation Play in Markets?

The question before a panel on Capitol Hill wasn't whether speculation impacts commodity markets, but whether the impact is too great? And, if so, how to limit that impact.

Published on: Apr 21, 2011

When most people hear "derivative" they think about the iffy financial instruments blamed for the near collapse of the U.S. financial system in 2008.

Most also hear "speculators" and think of traders out to make short-term profits at the risk of the long-term good.

There are, however, also derivatives in the agricultural trading world. So, did they play a role in the market collapse? And is investment buying by index funds responsible for artificial run-ups in prices of agricultural commodities? Does the volatility they bring to the commodities market hurt the buyers who are in the market to hedge their risk in the buying and selling of real, physical bushels of grain? And is the proposed rulemaking by the Commodity Futures Trading Commission to make agricultural swaps equivalent to their counterparts in the rest of the market a good idea?


Those were the questions the writers attending the 58th spring convention of the North American Agricultural Journalists posed to a panel of experts during the group's annual spring meeting in Washington, D.C. in early April.

Panelists included David Lehman, managing director of the commodity research and product development center with CME Group; Michael Masters, founder and chairman of the board of Better Markets Inc., and Todd Kemp, director of marketing and treasurer of the National Feed and Grain Association.

Predictably, the panelists had somewhat differing views of the danger (or benefit) that derivatives and hedge funds play in the markets.

Agricultural futures trading in live cattle, lean hogs, feeder cattle, corn, wheat, soybeans, soybean meal, soybean oil, rice and oats have been around since 1870. Similar trading in milk, cheese, butter, non-fat dry milk and whey are much newer: only about 10 years old, Lehman said.


Lehman said that futures trading on the Chicago Board of Trade and the Kansas City Board of Trade of set the benchmark for world market prices of corn, soybeans, wheat, soybean meal, soybean oil, oats and rice.

Livestock prices, he said, are much harder to benchmark because of the wide variation of quality and grade, which makes price discovery difficult.

Lehman said that speculators in the market are actually a good thing because they provide the liquidity that hedgers, those who deal in the physical delivery of grain and livestock, need.

He agreed that today's volatile prices have hit records, but pointed out that if they were adjusted for inflation from the previous highs in the1970s, which also came at a time of instability in the Middle East and a huge run-up in oil prices, they would be far, far higher.


Ag derivatives are a small part of the market, only about 10% of the futures and options contract size, he said, while oil, energy and credit derivatives are six times the size of the Chicago Mercantile market.