Commodity Hedge Funds Take a Hit in 2012

As reported by the Financial Times and Wall Street Journal in recent weeks, commodity funds took a significant financial hit in 2012 losing on average 3.7 of their value during that period. As reported in these articles, investors have been fleeing this asset class, causing the biggest decline since these asset flows were first tracked in the early 2000s. This may offer some comfort to those advocating against speculation in food commodities. But it points to the fact that institutional investors remain blissfully ignorant of the human costs associated with commodity speculation.

Hedge fund managers and commodity index funds that place big bets on rising commodity prices gamble on the hope that this asset class will continue to rise for the foreseeable future. But like similarly naïve assumptions made about bets on other derivatives – credit default swaps being the most memorable – these bets on rising food prices do not provide a hedge against investment risk as they were intended, but act as an accelerant in a market that has already witnessed dramatic swings. It is only when the losses become too much that investors head for the doors, as we have seen in recent months.

http://www.dreamstime.com/-image20331855What continues to happen is that investors use the commodity markets like they use other financial markets – to make bets on rising prices with the hope for positive returns on their investments. But the commodity futures markets are not intended for this purpose. Rather, these markets are designed to allow buyers and sellers of physical commodities to minimize their risk from rising or falling commodity markets and to create a measure of certainty in the price of grains, fuel, livestock and minerals. With the introduction of financial investors to these futures markets, the dynamic has changed, creating huge upward pressures on the prices of various commodities. However this is not primarily caused by natural conditions (weather conditions, demands for physical commodities and the like) but by the sheer volume of money from financial investors, driving prices skyward. Students of economics learn this basic fact on the first day of class: as demand rises so do prices.

However, as prices for commodity futures continue to rise, there comes a point where skyrocketing prices are no longer sustainable and the futures markets collapse. In the mean time, hunger around the world remains an ever-growing problem, only made worse by institutional investors and the world’s banks.

About the Author
John Richardson is the Co-Director of the Initiative for Human Rights in Business at the Center for Human Rights and Humanitarian Law at American University Washington College of Law.