As Americans get bludgeoned by ever-higher prices, Congress continues to blame “speculators” for their pain. Senator Joe Lieberman has even gone so far as to call for the ban of institutional investors from commodity markets. This is just populist grandstanding. Merrill Lynch explains why:
First, if speculators really are driving prices, higher trading volumes should affect all commodities equally, but they don’t:
Since 2001, global financial markets have seen an explosion in the growth of derivative financial instruments. As part of this general growth in derivatives across all asset classes, trading volumes and open interest in commodity derivatives have also increased. Yet only some commodities have experienced significant price appreciation, and we see no evidence linking increases in open interest and trading volumes to price rises.
If index funds were part of the problem, then one would expect to see all indexed commodities affected equally. Again, this is not the case. In fact, several commodities, like orange juice, have continued to appreciate despite being removed from the S&P Goldman Sachs Commodity Index (S&P GSCI):
On the back of strong demand, prices of non-index linked commodities have all gone up considerably, sometimes more than their index-linked counterparts, such as index-linked US nat gas vs. non-index-linked UK nat gas. The same can be said of other non-index linked commodities such as coal, rice, iron ore or steel. Also, commodities like orange juice, tin and platinum have all appreciated substantially after dropping out of the S&P GSCI.
The real culprit is less dramatic: supply and demand. Specifically, booming demand in emerging markets, fuel subsidies, and loose monetary and fiscal policy that have destroyed the value of the dollar.