One argument that you hear often from those who say that excessive commodity speculation is not a problem is that, if it was unduly affecting prices, there would be hoarding of physical stocks of those commodities. Paul Krugman recently used this argument to say that excessive commodity speculation is not a problem.
But Krugman misses a few key points:
1) Demand for food and energy is highly inelastic, meaning that even with large price changes, production and consumption may not be affected
2) Oil and natural gas can be stored above ground where it can be seen and measured, or it can be stored underground by not pumping it out of the ground
3) There is evidence of food hoarding, but much of that hoarding is unable to be measured
4) Even without physical hoarding, commodity futures prices directly affect spot (physical) prices. If futures prices rise, the physical prices also rise.
In his blog Accidental Hunt Brothers, Adam White offers two responses to those pointing to a lack of hoarding. One is that because of their trading strategy of going long (betting that prices will rise) for long periods of time, ”index speculators have their upward impact on commodities futures prices when they first put on the trade. We think that they have additional impact when they roll their positions but we don’t have any data to back that up the way we do with the initial impact.”
The second explanation is worth reading in its entirety, but basically says that because demand for food and energy are highly inelastic, “the price can rise dramatically before you get any reduction in consumption. Likewise it can rise dramatically before you get any increase in production. It takes time to grow food, drill oil, etc. So price increases might result in little or no inventory change in the short to medium term.”
Another argument White makes is that “oil and natural gas inventories are stored above ground and below ground. The above ground is to take care of ebbs and flows in ultra short term supply and demand (the U.S. has like 15 – 20 days of consumption in commercial storage at any one time). Below ground is where it accumulates if the demand is not there. Why would an oil producer pump more oil or gas than he has orders for?”
And there is indeed evidence of hoarding in agricultural commodities as seen in the two videos here. Glencore, Goldman Sachs, JP Morgan and other big commodity traders are all increasing their storage capabilities showing that they will be storing increasing amounts of commodities in the future.
While huge warehouses of rice from 2008 shown in the shocking second video may be visible and measurable, what Krugman and others forget is the multitude of other places that food commodities can be hoarded. Each and every family could, logically, increase its store of food as they hear again and again that food prices are rising. Bakeries and mills do the same thing. All of these other points of commodity hoarding are immeasurable, so we are really unable to know for sure how much is being accumulated. But it is logical that food is being hoarded all over the world.
Future prices do affect spot (physical) prices
Finally, futures prices directly affect spot prices in two ways regardless of inventory levels. First, many physical purchases of food and energy commodities around the world are done through long-term contracts that use futures prices as their benchmark. For example, a refinery might offer “100,000 barrels of light sweet crude to be delivered on the first of each month for the next 6 months at the WTI price ((West Texas Intermediate, or light sweet crude oil) + 0.3% per barrel”. A producer might come back with “WTI + 0.4% per barrel) etc. Same for grain, e.g. “100,000 bushels of hard wheat to be delivered on the first of each month for the next 6 months at the CME (Chicago Mercantile Exchange) price +0.3% per bushel”.