Wall Street funds vs. pig farmers
February 21, 2007
The New York Times recently reported that farmers of live hot and cattle in the Midwest have complained about the pernicious effects of Wall Street commodity index funds on their farms. These funds, it turns out, have suddenly become very prominent, making up for 47 percent of long-term contracts for live hog futures and present also in wheat, live cattle and corn. Why the complains? According to the article…
Many in the agriculture industry say that the index funds are increasing volatility, widening the spread between low and high bets on future prices, not only because of their sheer size but because the funds have tended to move in herds in response to market signals. Because the funds are prohibited from actually owning physical commodities, they ”roll” their futures contracts each month, often helping make the prices for commodities in future months higher. And each year the funds rebalance their portfolios in Robin Hood-like fashion, taking profits from commodities that have risen in price and reinvesting them in other, lower-priced commodities. The goal is to keep the commodities in the baskets at certain weighted percentages.
The key to the article is, why this sudden interest of Wall Street on pigs and sheep? Agricultural products, it turns out, are lumped together with energy products under the common umbrella of “commodities” index. The recent rise in energy prices has made commodities indexes very attractive, leading to increasing investment. The by-product of this has been a surge in agricultural positions of Wall Street funds. Interestingly, the farmers counterattacked by contesting the diffinition of commodities index, persuading the Commission to separate index funds in a separate category.
The news comes as traditional indexes are being combined, blended and deconstructed all over the country. Recently, another piece in the New York Times discussed the recent difussion of “fundamental indexers,” that is, funds that reweight traditional indexes such as the SP500 to correct for market imperfections. These developments prompt numeros questions to academics — what’s an index, really? How do they transform and reconstitute the securities they are supposed to represent?