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 “To an economist, a bubble is a period when the price is either
above or below its true economic fundamental value, which is
determined by the market,” explained U of I agricultural
economist Scott Irwin. “During those nine years, we experienced
painful increases in gasoline prices that were actually
justified by the market fundamentals; there was just too much
demand relative to supply, and price had to allocate.
“The controversy that began to surface was that index traders in
commodity futures markets were charged with overwhelming the
normal supply and demand in the markets and causing prices to
dramatically spike upward. The argument was being made
repeatedly to Congress and regulatory bodies that crude oil
prices were as much as 50 percent overvalued,” Irwin said.
Grain prices were also at record highs, particularly from 2007
to 2008—spring wheat was $25 per bushel and corn soared to the
unheard-of level of $8 per bushel.
The researchers used a new test to determine when a bubble
started and when it ended. They found that the massive price
spikes in crude oil and grain didn’t line up with the bubbles
they detected.
“When crude oil prices were spiking in the spring of 2008, for
example, when we had that incredible run-up in wheat prices, we
didn’t find a single day of bubbles,” Irwin said. “Bubbles in
the grain markets occurred more often during the second half of
the year rather than from February to May, which could
correspond to periods of production problems. By our test, the
prices were increasing dramatically (take corn prices up from $4
to $8 per bushel) but the move was not a bubble.”
The longest bubble lasted only 17 to 18 business days. To
investors, 18 days may seem like a long time, but when put in
perspective, over the nine-year span of the study, bubbles
occurred 2 percent of the time.
“Some may think that during price spikes the markets are
excessively speculative, excessively volatile, or excessively
hysterical,” Irwin said. “People see a big price spike and then
a rapid drop-off in price and call that a bubble without
realizing that it was absolutely necessary to equilibrate supply
and demand. This study says that there are some hiccups but
overall the market is doing a very good job of accessing and
getting the price right.”
Irwin said he hopes that objective evidence like this could lead
to more rational understanding of what’s going on in the
commodity markets, but he’s not particularly optimistic.
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According to Irwin, 99 percent of the conversations people have
about market fluctuations are about the dramatic upward price
spikes. In reality, when the researchers did find bubble
behavior, about one-third of them were downward in price.
Another important implication of this research is on speculation,
Irwin said. “The new index investors are a new version of
speculator. These investors have a lot of money, and they can hit
the market in waves, so there is potential for excess price
pressure. However, commodity futures markets are not the type of
market one would suspect of being highly susceptible to price
bubbles in the first place.
Irwin used the housing market in 2006 as a counter-example. “This is
a market with slow turnover, and it is hard to short the market if
you think it is overvalued,” he said. "This was compounded by cheap
credit and something of a social mania. But in this study there is
really limited evidence that speculation was harming producers or
consumers of grains.”
Irwin said the data in this shorter nine-year time period is very
representative of long-term results. He referred to another study
that looked at 40 years of grain market data, beginning in 1970.
“The last comparable boom in prices was 1973 to 1976-77,” he said.
“We actually found evidence of more bubble behavior way back then,
than we do now.”
“Price Explosiveness, Speculation, and Grain Futures Prices,”
written by Xiaoli Etienne, Scott Irwin, and Philip Garcia, appears
in the American Journal of Agricultural Economics.
[Debra Levey Larson, M.A., University
of Illinois
College of Agricultural, Consumer and Environmental Sciences]
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