A Bitter Brew? Futures Speculation and Commodity Prices

We contribute to the debate in two, related ways. First, we introduce a new theoretical model that explains under which conditions a 'perfect storm' is likely to exist during which futures speculation drives up spot commodity prices. In the model, both spot demand and supply conditions as well as the micro-structure of futures markets and commodity inventories play an important role.

Since our theoretical model predicts that the effect of futures speculation on commodity prices, when it exists, is spiky and persists for short periods, our second contribution consists of the introduction of a highly flexible, non-parametric model to capture this effect. When matched with a data set for the world coffee market over the last 20 years, we find that, although supply-side developments are the most important contributors to rising coffee prices, the impact of futures speculation is significant, both statistically and economically.

With a series of extensive robustness tests, included in the Appendix to the paper, we are able to explain why traditional, mean-variance based methods have failed to identify the effect of futures speculation, and can establish causality.

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