Excessive Wheat Futures Speculation Needs New Limits - Report
June 23 2009 - 10:30PM
Dow Jones News
Rampant speculation in wheat futures by commodity index traders,
who control billions of dollars worth of contracts, is ruining the
price hedging system used by the farm sector, which can translate
into higher prices for food manufacturers and consumers, a Senate
panel said in a report released Tuesday.
The Senate's Permanent Subcommittee on Investigations conducted
a yearlong investigation of the wheat market and suggested in a
247-page report that new limits are needed for index traders, and a
government regulator said the situation warranted a "fresh"
review.
The report and the subcommittee's chairman, Sen. Carl Levin,
D-Mich., blame the Commodity Futures Trading Commission for
facilitating the index traders by allowing some to go well beyond
normal buying limits. The CFTC is the regulatory agency charged
with overseeing futures markets.
"The CFTC helped create the problem by allowing some index
traders to exceed the standard limit on the number of wheat
contracts that traders are supposed to be able to hold at any one
time," Levin said.
Traders are supposed to be limited to holding 6,500 wheat future
contracts, but the CFTC has granted several exemptions and
"no-action" letters that allow traders to go well above the limit -
up to 53,000 contracts in one instance.
"Together these hedge exemptions and no-action letters permit
six index traders to hold a total of up to 130,000 wheat futures
contracts at any one time," the report said. "CFTC data indicates
that, from 2006 to mid-2008, the total number of outstanding
contracts ... attributable to commodity index traders in the wheat
market was about 200,000 contracts. That means that the six index
traders granted waivers from trading limits may have held up to
about 60% of all the outstanding wheat contracts held by index
traders."
The value of the investments in commodity indexes "has increased
an estimated tenfold in five years," according to the report, "from
an estimated $15 billion in 2003 to around $200 billion by
mid-2008."
Bart Chilton, a CFTC commissioner, said Tuesday he has had his
own concerns about the detrimental effect of "excessive
speculation" and called the exemptions "questionable" and deserving
"a fresh review by the commission."
Heavy buying by index funds that only take long positions -
which are essentially bets that prices will move higher - are "at
least in part responsible for higher wheat prices and the "lack of
convergence" between futures and spot prices at the expiration of
contracts," Chilton told Dow Jones Newswires. The long-only stance
of index traders is unlike the behavior of other market
participants who follow market trends and alternate between long
positions or short positions, which are expectations prices will
decline. "This is a concern because it creates uncertainty in the
marketplace and undermines the price discovery process."
In addition to wheat futures at the CBOT, a subsidiary of the
CME Group Inc. (CME), wheat futures are also traded on the Kansas
City Board of Trade and the Minneapolis Grain Exchange.
The problem caused by index traders became particularly
exaggerated last year when futures prices were more that $2 per
bushel higher than cash prices during "convergence," the time when
futures go into delivery and futures prices and cash prices are
supposed to come together in order to facilitate hedging.
"The futures price became disconnected from the cash price,
staying far higher than the cash price due to the index traders,"
Levin told reporters.
CBOT wheat climbed to a record high in early 2008 amid global
crop failures and remained historically high last summer, when the
gap between cash prices and futures widened to more than $2.
Producers had responded to high prices by expanding plantings for
the 2008 crop, which led to a flood of soft red winter wheat
hitting the market at harvest.
Levin said Tuesday the index traders must be reigned in to bring
back harmony to the system that was originally meant to help
farmers, grain warehousers, and food producers hedge crop
prices.
The excess of index trading has endangered the original purpose
of the futures market, said Senate aides.
"The data shows that, during the period from 2006 through 2008,
index traders held between 35% and 50% of the outstanding wheat
contracts ... on the Chicago exchange and between 20% and 30% of
the outstanding wheat contracts on the smaller Kansas City Board of
Trade," according to the Senate report.
That excess pushed open the differential, or "basis," between
futures prices and cash prices, meaning farmers and grain elevators
"could no longer rely on the futures markets to reliably price
their crops and effectively manage their risks over time," the
report authors said.
The key to bringing back harmony between futures prices and cash
prices, the report said, is limiting all index traders to the 6,500
wheat contracts - the same limit applied to other types of
traders.
Levin told reporters he agreed with the conclusion, but took it
a step further and said the CFTC may have to lower that limit to
5,000 contracts.
(Tom Polansek and Sarah Lynch contributed to this story)
-By Bill Tomson, Dow Jones Newswires; 202-646-0088;
bill.tomson@dowjones.com