Volatility causes speculation. Speculation doesn't cause volatility. We need to understand the reality of food supplies and focus on what is important, according to MLI Commentary.

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OTTAWA, Nov. 8, 2012 – Reliance on just-in-time supply delivery and a severe drought in central North America were responsible for this summer's spike in food prices – not speculators, the Macdonald-Laurier Institute says in its latest Commentary.

It has become all too predictable and easy to blame speculators for rising commodity prices while ignoring market fundamentals, Larry Martin, a Canadian risk management expert in the agri-food sector, says in the MLI Commentary. Yet the market for agricultural commodities works very well, indicating that policy-makers would be ill-advised to heed poorly thought-out calls to curb speculation in these markets.

"While there are many and complex factors that affect price movements," Mr. Martin says, "a very basic one is the stock-holding behaviour of end users. The world grain processing industry has moved almost exclusively to just-in-time shipping of their raw material."

End users in this sector from feed and flour mills to cereal manufacturers don't want to tie up their capital in grain storage facilities and inventories. So they purchase supplies as they need them.

Just-in-time delivery keeps costs down when there is plenty of inventory and good infrastructure. But when there is shortage, not so much.

"What if inventories are already low relative to demand and a USDA report comes out forecasting a lower yield?" Mr. Martin says. "Some end users will become concerned about security of supply and buy a little extra just in case."

Some may call this hoarding, as Mr. Martin notes. Others will call it prudent risk management to ensure plants are kept open and employees continue working.

"Whatever it is, the effect is to increase prices – and the lower the inventories and the more just-in-case buying there is, the more prices will rise."

In recent years, however, those price increases have been short-lived because the shortages have turned out to be not as bad as expected.

While speculators do have a short-term impact on prices, long-term evidence is clear that fundamentals drive markets in the long run, Mr. Martin says.

In fact, speculators have an important role to play by providing liquidity that hedgers need to balance the market. Limiting the speculators' role would disrupt markets.

"In a world with real problems, how much harm can be done by focusing on non-problems with solutions that can do harm – in this case, by potentially jeopardizing the liquidity needed in a well-performing market," Mr. Martin says.

"The focus should be on how to make sure people have enough to eat and to have fewer reasons to resort to revolution and terrorism. My advice to policy-makers: Let's try to understand the reality of the food situation and focus on what's important."

MLI Commentary: Are higher prices driven by speculation or fundamentals?, by Larry Martin, November 2012

Larry Martin is a principal in Agri-Food Management Excellence Inc., a company that specializes in management training for the agri-food sector. He has taught courses on hedging with futures and options to more than 1,000 Canadians over the past 40 years. He writes a monthly column on commodities for Food in Canada Magazine and assists a number of Canadian businesses with their risk management programs.

The Macdonald-Laurier Institute is an independent non-partisan Ottawa-based national think tank devoted to the development of Canadian public policy.

For further information, please contact:

Tripti Saha
Communications Officer
Macdonald-Laurier Institute
613-482-8327 ext 105
tripti.saha@macdonaldlaurier.ca