WASHINGTON Commodity index traders had snapped up more than 200,000 wheat contracts by mid-2008 that helped fuel last year's record jump in prices, which ended up raising costs for both industry and consumers, according to a year-long bipartisan Senate probe.
The report found large wheat purchases on the Chicago Mercantile Exchange pushed up futures prices, disrupted convergence between futures and cash prices and increased costs for farmers, the grain industry and consumers.
"It is another case of speculative money overwhelming a market, and federal regulators failing to take the steps needed to protect the market," said Carl Levin, chairman of the Senate Permanent Subcommittee on Investigations, who released the 247-page report along with Tom Coburn, the panel's top Republican.
"It is time for the CFTC (Commodity Futures Trading Commission) to change course, rein in commodity index traders, and clamp down on excessive speculation that is disrupting commodity prices," said Levin.
Prices for most commodities soared to historic highs during the middle months of 2008. Wheat soared to a high of $13.34 a bushel in Chicago and crude oil shot above $147 a barrel.
Some analysts blamed the rise on hot money inflows from index, pension and hedge funds looking for new investments.
"As the Commission continues our own analysis and appropriate regulatory responses, Chairman Levin's recommendations will be given the utmost attention and careful consideration," said Gary Gensler, the recently confirmed CFTC chairman, who has acknowledged that financial investors, index funds and others contributed to last year's asset bubble.
The wheat industry was furious last year when Chicago Board of Trade wheat futures and cash prices at CBOT delivery points failed to "converge," or come together during delivery periods, a process essential for proper hedging. Convergence problems also occurred in other commodities, including cotton and rice.
The Senate study found commodity index traders increased their holdings from about 30,000 daily outstanding wheat contracts in 2004 to 220,000 contacts in mid-2008 at the Chicago Mercantile Exchange, the largest wheat futures market, before dropping to about 150,000 contracts at year's end.
Overall, index traders, which take on long positions and hold them for extended time periods, held between 35 percent and 50 percent of outstanding wheat contracts on the Chicago exchange since 2006.
There also was "substantial and persuasive evidence" showing that by purchasing so many contracts, index traders boosted demand, increasing the gap between futures and cash prices and making it difficult for prices to converge when futures contracts expired.
At the same time contracts held by index traders soared, the gap between futures and cash prices at contract expiration rose annually from 13 cents a bushel in 2005 to $1.53 in 2008.
The CME Group, CBOT's parent, implemented new contract specifications to improve hedging that take affect later this month.
Industry groups have said that while a mismatch in cash and future prices among many commodities has improved from 2008, problems in wheat are evidence that more needs to be done quickly.
CFTC SHOULD PHASE OUT LIMIT WAIVERS
In an effort to stop excessive speculation, a problem the CFTC helped cause, the report recommended the agency phase out existing waivers and enforce the standard limit of 6,500 positions for index traders in the wheat market. If prices fail to improve following the phase-out of waivers, the CFTC should consider bringing back a 5,000-contract limit.
The Senate panel criticized the CFTC for being too lax on position limits, including allowing four swap traders since 2005 to exceed the 6,500 limit, including one trader allowed to hold up to 53,000 contracts at a time.
The crackdown on speculation has come from all fronts. Lawmakers in Congress, determined to prevent a recurrence, are looking to give the CFTC more funding and authority, including keeping excessive speculation in check.
And finance ministers from the Group of Eight nations -- Canada, France, Germany, Italy, Japan, Russia, Britain and the United States -- said at their recent meeting that volatile commodity prices put their economies, which have shown growing signs of heading toward recovery, at risk.
Not everyone is convinced speculation is creating problems.
A study by top agricultural industry consultant Informa Economics issued in February, commissioned by CME and others, concluded there was no solid evidence that speculation had caused a lack of convergence.
Levin said the CFTC should take a closer look at other commodities, such as oil, to determine whether index traders have played a role in excessive speculation and if position-limit waivers also should be removed.
"If excessive speculation is going on, put a lid on it so that these markets continue to function in response to supply-and-demand market factors not to demands created from financial engineered" instruments, said Levin.
Many fear that by implementing rules to prevent speculators from driving up commodity prices, the risk is that markets becomes less efficient. Fewer speculators would mean fewer traders willing to absorb risk. This could boost costs for some businesses and lead to higher prices for consumers.