February 25, 2015
Executive Summary
Prices respond to market news reports (e.g., droughts, production changes etc.), but often not in the way people assume. Much, if not most of the time, a commodity’s seeming price response to news is instead due to the effect of money flows—large amounts of money flowing in from other financial markets—not to the news itself. This paper explains how money flows entering commodity and other markets: 1) exacerbate price reactions to news reports; and 2) often are the sole driver of price changes that are wrongly ascribed to news reports.
Given a steady or rising supply of a commodity, prices can go higher over time only if new and additional money is spent in that market. If monetary expenditures do not increase rapidly, prices cannot rise, and they are also less responsive to news. But when money flows are heavy, prices are more volatile and more responsive to news reports, even though they shouldn’t be according to commonly accepted commodity fundamentals.
Money flows constitute an independent causal force on prices that have a life of their own; they represent additional demand. Often, it is not the news causing prices to rise; it is that the news comes out while prices are rising. Market participants, assume the market is legitimately responding to the news itself, but it is instead responding to increased monetary demand (the ultimate driving force of physical demand), independent of the news.
Money flows move prices regardless of what the news is or whether there is any news at all.
When increased quantities of money are injected slowly and evenly into consumer goods markets, people rightly accept that prices are rising due to inflation. But when money is injected suddenly and heavily into commodity markets specifically, observers instead wrongly attribute the rising prices to a non-specific “increased demand” or some other cause related to the fundamentals of agriculture, metals, or energy. But the unrecognized cause in such circumstances is instead money flows, i.e., the unrecognized driver of (especially volatile) price inflation.
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Page 1

New reports regularly come out that roil the markets. It appears as though the price response to a particular news report reflects the true, serious evaluation of the report. But the market response is usually not what people think it is, because changes in the quantity of money flowing through different financial markets usually exacerbate the market response to the news items. These money flows can also dictate the entire price movement during a period of time, leaving news reports to have no effect other than coincidental timing.
Traders, with access to very large amounts of cheap money from different banks and money markets, use news events to inject new money into the market, pile on securities and push prices far past their point of true adjustment to the news item. The more access they have to low-cost money, the more their money flows exacerbate the news-based price response. Additionally, longer term investors use the news events as catalysts for entering or exiting the market. These actions cause passive market participants and other observers to believe that the news is more significant than it usually really is, and misleads them as to the true drivers of longer-term market prices. Conversely, the markets often move solely due to money flows, but observers wrongly attribute the move to whatever news is taking place at the time, failing to grasp the true cause of price movements.
This paper will demonstrate, using the corn markets as an example, how and how often such sequences of events take place in the commodity markets. The goal is to demonstrate that news items commonly seen as driving prices higher over the longer term are not the actual drivers. Data will show that money flows are the sole cause of permanently higher prices, not market news items, market fundamentals, nor other factors commonly accepted as drivers of ever higher prices.
The authors intentionally repeat some points in this paper because they are essential to our argument, yet unfamiliar to many commodity market participants.
News Alone Could Never Drive Prices Higher
Only two things can make the price of anything change: demand and supply. Demand is the quantity of money spent for something; supply is the number of units of the thing sold.
1 Anything that is considered to affect commodity prices, such as weather, plantings, yield, usage, ethanol demand, need, fear or greed, can be transmitted to prices only by changing the quantity of money spent or the number of units sold in a market.
1
While conventional economics calls demand the number of physical units sold, this is incorrect. Prices are in monetary units and cannot be derived by the interaction of two physical variables. Conventional economics textbooks themselves explain that changes in the demand of physical units is ultimately driven by changes in monetary spending, both in microeconomics and macroeconomics
(historically, demand was defined by textbooks only as the quantity of spending). Economists have severed the link between spending and physical demand and trained themselves to focus only on physical demand without considering its driver. Physical demand is necessarily just the flip side of supply, as everything that is produced and offered for sale will be sold at some price.
Physical demand thus grows generally in line with production, and thus changes relatively slowly over time, while changes in monetary spending change by very large degrees during certain periods.
Page 2
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As a visual aide, consider the chart of corn prices in Figure 1 . In the chart, the average corn price of any given year is equal to the amount of money spent in that year divided by the number of bushels sold. The additional volume of spending through time is the only way that prices were able to rise as supply was expanding—demand growth (spending) outpaced supply growth.
Figure 1 : The evolution of corn prices, with the associated derivation of selected annual average prices via the price fomula.
7.00
$ ,
, ,
,
= $ .
$6.90
6.00
$ ,
, ,
,
= $ .
5.00
4.00
3.00
2.00
$ ,
, ,
,
= $ .
$ ,
, ,
,
= $ .
$ ,
,
$2.29
,
,
$2.39
= $ .
$2.53
$2.08
$ ,
,
$3.27
$2.28
,
,
= $ .
$2.72
$2.43
$1.94
$ ,
,
$1.81
$1.87
,
,
= $ .
$3.05
$2.43
$1.99
$2.33
$ ,
,
$2.06 $2.00
,
,
= $ .
$4.19
$4.08
$ ,
,
1.00
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
,
,
$5.35
$3.57
= $ .
2010
$6.20
2012
This understanding that prices can go higher only with additional amounts of spending reveals that a news report alone, no matter what it is, could never send prices to a new high; additional spending must be initiated as well. If supply is the highest it has ever been, prices can go higher than they have ever been only if a greater quantity of money is spent in that market than has ever been spent.
It should also be understood that the news does not enable people to spend additional quantities of money to respond to the news. They cannot spend more if they haven’t obtained more money. Businesses annually spend all the money they have available to them. They allocate (invest) all their capital that is in excess of profits/interest. Thus, participants in the commodity markets do not have additional excess money on hand to spend at any given time. Businesses, in aggregate, do not make their own money; businesses produce only goods and services. The only money-producing entity is the Central Bank, and it produces additional money each year. It is the sole source and enabler of increased spending economy-wide.
Thus, unless money enters the commodity markets from being channeled by other people in other markets (i.e., unless money flows take place), traditional players in the commodity markets are able to spend more in the
Page 3
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commodity markets through time only as quickly as the quantity of money in the economy grows through time— about 3-4% per year, on average. But if these players do not receive additional money, they cannot bid prices higher (given that supply does not declcine) no matter what the news is.
But commodity market participants do actually bring in money from other markets. The type of participant with the greatest market share in the commodity markets are the so-called “speculators,” or more accurately, Wall St.
banks and hedge funds. These players have access to money that are orders of magnitudes greater than what circulates in the commodity markets at any time. Periodically these Wall St. players change the composition of their investment portfolios to include commodities. When they do, they buy commodities across the board, which explains why most commodity prices move in tandem over time even though they have different fundamentals.
These sudden inflows and outflows of money are commonly called “money flows,” since the money virtually flows from one market to another.
Thus commodity prices experience two different demand effects: they rise slowly over time due to normal price inflation, and, they rise more rapidly during certain periods of time when new and additional money flows to commodities suddenly from other financial markets.
Confusion About News and Prices in 2008
Consider the period of rising (cash) corn prices between 2003 and 2008, when futures prices rose from $2.38 to a height of $7.25 (an all-time high). The supply news over this period was that supply rose from 10,619 bushels to
13,659 bushels, an increase of 28.6%. Had the quantity of spending during this period been static, every time supply increased, prices would have fallen, since the same amount of spending would have been distributed over a larger number of units. This hypothetical scenario keeping spending constant and adjusting prices for demand changes only is shown in Figure 2 .
Figure 2 : How corn prices (black line) necessarily would have evolved between 2003 and 2008 had spending been held constant, given actual supply changes (gold line).
$2.50
$2.40
$2.30
$2.20
$2.10
$2.00
$1.90
$1.80
$1.70
$1.60
$1.50
Jan-03 Jan-04 Jan-05 Jan-06
Theroretical Corn Price
Jan-07
Supply
Jan-08
16,000
15,000
14,000
13,000
12,000
11,000
10,000
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But As Figure 1 shows, new and additional money did hit the corn market in the second half of 2006. Observers struggled to find reasons for the phenomenon of rising prices. They looked at the news at the time and figured that it must somehow be responsible, even though the news did not justify higher corn prices.
Economists and the news media understand—rather abstractly—that for prices to go higher, demand has to rise.
Indeed, demand as they know it—the number of physical units purchased—was rising over time (though it actually fell in 2006 and 2008!), but that was merely because more corn was being produced. (They were confusing increased supply with increased demand). On way economists and the news media justified rising prices was by looking at the increased number of units sold over previous years and determining that that was what constituted the increased demand that was raising prices, even though increasing numbers of units sold had not raised prices for over two decades. The number of bushels sold had increased 65% over the prior 20 years without raising prices, but now, even though physical demand (units sold/used) was averaging only a 4% per year increase—in line with that of the prior 20 years—it was now somehow assumed to be the thing somehow raising prices by more than 50% per year.
As another way pundits tried to justify rising prices in the face of increasing supply was by looking at the world around them and coming up with the idea that there was increasing “demand” from China and other emerging economies, even though those entities were not buying any more corn or agricultural commodities as a whole than they had before. Another factor, increased demand for corn for ethanol use, could theoretically have raised prices due to the additional spending from ethanol producers, but other research has shown that their increased spending was offset by decreased spending by traditional market participants.
2
The fact that it was not only corn prices that were rising, but all commodity prices rising together, including energy, metals, and raw materials, should have been the clue that the driving force was not something related to corn or agricultural commodities in particular. Instead, it was new and additional money—increasing monetary demand—hitting all commodities at the same time, as massive funds from Wall St. were channeled into the commodity markets, as shown in Figures 3 and 4 .
2
See the link to the paper on ethanol on the last page of this document.
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Page 5

Figure 3 : Total futures market spending since 1986 on the commodities listed in the chart.
$600
$500
$400
$300
$200
$100
$0
1986 1991 1994 1997 1999 2002 2004 2007 2009 2012
Source: CFTC, authors’ calculations
CrudeOil
NaturalGas
Soybeans
Corn
Wheat
OrangeJuice
Cotton
Coffee
Sugar
LiveCattle
LeanHogs
SoybeanOil
Copper
Platinum
Silver
Gold
Figure 4 : Corn market spending divided between Wall Street (Financial/Speculator) and non-Wall
Street players (left-hand side is price, right-hand side in billions of dollars of spending).
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
2006
Financial/Speculator Money Flow
Nonclassified Purchasers
Commercial Money Flow
Corn Price $/Bushel
2007 2008 2009 2010 2012
$60
$50
$40
$30
$20
$10
$0
2011
Nonetheless, when all commodity prices suddenly collapsed together in summer 2008, pundits still looked to the news of each individual commodity to try to explain the massive price collapses of 40-60%. The chief economist of a premier agricultural economic consulting firm cited the USDA report in early July 2008 which showed very slight forecast changes of corn production and stocks (including an unchanged physical supply/physical demand relationship) as occurs many months each year, as the catalyst that sent corn prices plummeting 59% over the next four months (markets usually fully digest news within several days). He did not explain how very minor
Page 6
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changes in corn fundamentals this time moved prices so much when they usually do not. Nor did he explain how news specifc to corn only was supposed to have driven all other commodity prices lower as well—at the very same moment.
The USDA report for early July 2008, when the decline began, showed production falling a mere 0.17%, and supply rising 1.10%. In other words, they were largely unchanged. But this was seen as the thing that should cause corn prices to fall over 50%. Plus, corn prices had already fallen by 10% from their high before the report came out. Prices turned from going higher to suddenly going lower during an absence of USDA reports.
A well-respected agricultural economist at a midwestern university in the corn belt argued instead that the sudden reversal and collapse of corn prices was due to: 1) the marginal buyer of corn changing from foreign importers to ethanol producers; and 2) the break-even price of corn changing. Other economists had different explanations, including rainfall amounts, crude oil prices, ethanol prices, Argentine exports and Chinese imports.
Here are various other explanations given in the media and by different experts for why different individual commodity markets were collapsing (simultaneously) during the summer and fall of 2008:
Wheat : The expanding Northern Hemisphere harvest bolstered forecasts for a bumper crop in the United States and record world wheat production in 2008-09. … Bakingbusiness.com
Nickel : Falling demand from stainless steel makers. … Nickelinvestingnews.com
Crude oil : 1) Technical factors; 2) Investment Banks unwinding positions; 3) demand slowing because prices were high. … Money.cnn.com
[But on July 3rd, just prior to the start of the price collapse, Bloomberg news stated: “Crude oil rose above $145 a barrel to a record amid signs global demand for fuels, particularly from China, may strain supplies”
Additionally, the IMF had just reported that it expected crude oil prices to remain high for years to come, just as crude oil reached new highs. The IMF apparently did not believe high prices would affect demand as others later claimed was happening.]
Copper : Higher stocks and demand fears.
… Reuters News
Live cattle : Concern about domestic and export demand. … North Dakota State University
Agriculture News
Precious metals as a group : Poor auto sales (platinum and palladium are used in the manufacture of catalytic converters), and the energy crisis. … Palladiuminvestingnews.com
Agriculture prices in general : High prices choking off demand (prices went down because they went up). … ABC News
Corn, soybean, and wheat prices in particular : Favorable weather led to a greater production than expected. … Allianz.com
(Investment Bank)
[Corn production, after prices had already fallen for a month, was expected to see a mere 4% increase, according to USDA reports. Wheat was expected to see a 2.5% increase, and soybeans production was actually expected to fall, not rise (which should send prices higher, not lower).]
Page 7
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It should be obvious that most of the various commentators were grasping at straws, whether they knew it or not.
They did not know what was moving prices, so they simply looked to the news of the day and assumed that whatever it was, it was driving individual commodity prices. They could not see the forest for the trees.
When prices rise, analysts tend to argue that it is increased demand that is the cause. When prices fall, they say it is increased supply. But the fact is that the supply and demand they are referring to—physical supply and demand—both tend to rise and fall together. They are two sides of the same coin. So the analysts are really just picking and choosing the side of the supposed supply/demand equation that suits the needed explanation at any given time.
Those who commented that subtle changes in production and supply were responsible for disproportionately massive moves in prices did not try to explain how, for example, a 1% change in production could lead to a 30% change in price during recent periods when traditionally such a change in production would lead to, say, a 3% or so change in price .
The commentators that said that commodity prices were falling due to a decrease in demand were both right and wrong. They were right in that there was a slowing of some kind of demand, but they were wrong in that what they call demand—physical units purchased—was declining, as units purchased did not fall for most commodities. Again, what changed was the monetary demand , i.e., the quantity of money spent to purchase those units. This, in turn, was declining due to the same factor that causes recessions: the slowing of money creation by the central bank, which raises interest rates and reduces the pace of both business and consumer spending. The slowing of money creation and rising rates also causes Wall St. to face higher short-term borrowing costs, falling asset prices and losses on investments, which in turn causes it to unwind positions—including commodity positions. This is what casued the reversal of money flows out of commodity markets as well as most other asset market in the summer/fall of 2008.
It should be noted that one of the primary reasons given for the rise in agriculutural commodities duing 2006-
2008 was the supposedly large consumption of agricultural products purchased by China and other emerging economies. But as commodity prices collapsed by half, these emerging countries bought the same amount as before. So different reasoning tends to be used at different times to explain prices changes, with many of the hypotheses incompatible with the data.
Even if economists and the news media had a vague idea of what was going on, they were still mostly lost in the big picture. Meanwhile, everyone believed them and accepted the idea that minor changes in production or some vague changes in “demand” were driving prices, having no idea that what was going on was solely a monetary phenomemon related to the banking and financial system.
The 2006-2008 commodity price increases are a microcosm of what typically happens in the world of commodities markets over longer periods: money moves prices higher, even as the production and supply growth indicates that prices should instead be moving lower.
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Page 8

Confusion About News and Prices in 1973
The other major surge of commodity prices in recent history, that of 1973, was also an instance where experts attributed the rise to news instead of to the actual cause, i.e., money flows. When commodity prices suddenly soared 200-400% that year, observers looked to global current events for explanations. For oil prices, they convinced themselves that OPEC’s production cuts that caused a mere 5% reduction in global supply for one single year was the reason oil prices rose 825% over the next seven years. This, in spite of the fact that the world production and supply of oil not only returned to its previous highs the very next year, but reached new highs every year for the rest of the decade (and even though world oil production fell 14% in the early 1980s while prices fell instead of rose).
To explain rising crop prices specifically, agricultural economists, traders, and the news media simply observed the news of the day of large corn and wheat purchases by the Soviet Union. Since prices were rising at the time, experts assumed Soviet purchases to be the major cause. As with the OPEC explanation for oil, they still accept this explanation even today. It is now considered a fact just because it has been repeated so many times.
Indeed, it is impossible for the Soviet Union to have driven up most agricultural prices, especially since it mostly did not actually buy any agricultural commodities aside from corn and wheat. The USSR would have had to actually spend money and buy products in order to raise prices.
3 But even for corn and wheat, the two commodities the USSR did buy (or that the U.S. government purchased on their behalf), the relatively small purchases of corn and wheat were not enough to raise prices more than a couple of percent, if that. Nor did the magnitude of the purchases coincide/correlate with the height of prices.
Figure 5 shows how small the Soviet
Union corn purchases actually were. Wheat purchases were comparable in magnitude.
Conversely, exports increased 40-fold between the end of WWII and 1959, with Korea alone (suddenly) buying proportinately as much in 1959 as the Soviet Union did in the 1970s, yet this did not raise prices. No, prices during this period actually fell by more than 50%. Thus, it is never mentioned. But surely, had prices popped higher during 1960—for whatever reason—traders and the media would have pointed to Korea’s massve purchases as the reason when it was not the reason. It is but another example of analysts selectively choosing causative economic events and ignoring inconsistentcies.
Instead, what actually happened in 1973 was that large money flows suddenly hit the commodity markets—that time as a result of the collapse of the Bretton Woods quasi-gold standard. Commodity prices had been flat for twenty-plus years while the value of the dollar was being kept constant relative to gold and to other world currencies. The dollar exchange rates were held fixed by the Federal Reserve and by foreign central banks buying and selling currencies. But during the late 1960s the United States began printing massive amounts of money.
3
This confusion is similar to that of today’s argument that China drives U.S. agricultural prices when it, for the most part, does not buy American agicultural products.
Page 9
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250,000
Figure 5 : Corn prices (black line) and the sum of all corn purchases made by different countries, showing that purchases by the Soviet Union were relatively small and did not occur in line with corn price movements.
(1000MT)
200,000
150,000
Domestic Buyers
Jordan
Ethiopia
Costa Rica
Venezuela
Cote d'Ivoire
Morocco
Senegal
Cyprus
Nicaragua
Mexico
Romania
Chile
Tanzania
Zambia
Vietnam
Former Yugoslavia
Switzerland
Poland
Japan
All Others
Indonesia
El Salvador
China
Nigeria
Brazil
Guatemala
Turkey
Pakistan
India
Kenya
Iran
Dominican Republic
Peru
Former Czechoslovakia
Jamaica
Lebanon
Philippines
Korea, South
Corn Price
Nepal
Honduras
Ecuador
Bulgaria
Ghana
Argentina
Bolivia
Malta
Colombia
Panama
Congo (Kinshasa)
Algeria
Norway
Egypt
Trinidad and Tobago
Israel
Taiwan
Canada
USSR
Sum of all corn
Purchases
100,000
Domestic
Buyers
Corn Price
Corn Price
Corn Price
$7.00
$6.00
$5.00
$4.00
$3.00
$2.00
50,000
Corn Price
$1.00
Foreign
Buyers
USSR
Japan
0 $0.00
To keep this money off the market, foreign central banks had to buy the excess dollars, and to do this they had to print more of their own currency, resulting in domestic price inflation in those countries. In March 1973, when
Germany’s Bundesbank was buying as many as $6 billion dollars per day, America’s largest trading partners, unhappy with the increased domestic price inflation the dollar purchases were bringing about, agreed to quit buying dollars and let exchange rates float.
The result was that all the dollars that central banks were buying and hoarding were released back on the foreign exchange market, and the dollars that foreign trade partners were holding were exchanged for American goods
(excess dollars had already been leaking into the commodity markets to a smaller degree over the prior several years). These actions, in turn, caused the dollar to plummet. The dollar fell 35% between 1971 and 1973, and by more than half over the next seven years. The newly-released dollars flowed first into commodity markets, suddenly pushing prices higher and keeping them higher over the decade. Dollars similarly flowed into the real economy, giving America high consumer price inflation that peaked at 15% in 1980.
As Figure 5 shows, the relatively small Soviet agricultural purchases were even smaller than those of all other foreign purchasers together, who had all began buying commodities in large volumes with the dollars they wanted to unload. Prior to that, there were very few U.S. exports to speak of. Countries began importing American corn and other products because they were holding unwanted dollars (as they still do today, due to our trade
Page 10
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deficit). But all of the purchases by foreigners paled in comparison to the purchases of domestic buyers, who were the main ones pushing up prices, since they spent many of their newly acquired dollars on commodities
(i.e., their total (monetary) demand was much greater than that of foreigners).
News outlets and commodity market participants then, like today, did not consider that all commodities were moving together simultaneously—both ones OPEC and the Soviet Union could and could not affect. They did not ask what larger, macroeconomic force was influencing the entire market as a whole. They, instead, looked narrowly to the news in their particular market, contriving explanations, without trying to understand how shortages or additional purchases in one or two commodities would be able to affect tens of other commodities by a factor of five to ten times the force exerted in those one or two markets.
It should be understood that prior to 1973, commodity prices did not respond to news reports as they do now. As an example, consider Figure 6 showing that throughout the most severe wars and middle east crises of the last century, oil prices barely budged. This was because there was not money sloshing around the world markets then as there is today. Wall St. traders did not have instant access to trillions in cheap overnight loans then that they do now. But today, news of any Middle East conflict sends oil prices spiking on supposed “supply concerns.”
Figure 6 : World oil prices between 1861 and 2010.
$100
$90
$80
$70
$60
$50
$40
$30
$20
$10
$0
Israeli Six-Day War
OPEC Created / members nationalize oil resources
Various internal Iranian conflicts
Suez Canal conflict
Arab-Israeli War
WW II
But as Figure 7 shows, the supply of oil should almost never be a concern, as it does not usually vary significantly. Supply continues growing pretty steadily over time, falling only a few percentage points, if at all.
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Page 11

Figure 7: Evolution of world crude oil supply.
100.00
95.00
90.00
85.00
80.00
75.00
70.00
65.00
60.00
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Total World Supply
Source: U.S. Energy Information Administration (EIA)
The same lack of volatility characterized all other commodity markets as well during the pre-1971 gold standard period. Indeed, during the 1950s and 1960s commodity prices were almost completely flatlined relative to all other periods in history. Though supply changed a lot over this period, news of supply changes and factors like weather, usage, and “fear” that are claimed to drive supply changes and prices today, didn’t alter prices. The news was just as important and volatile as most other periods in time, but the market could not react to the news very much without excess money to trade with. Calm money means calm markets, and vice-versa.
Confusion About News and Prices in 2014
In early 2014 tensions between Ukraine and Russia were at the top of the news headlines. This was seen as significantly affecting the world corn market, since Ukraine is the fourth largest corn exporter in the world.
However, there was no real reason for the Ukraine situation to affect world prices for two reasons. First, the world export market for corn is very small—only 14% of world production (and it is all of world production that determines world prices, not just exports). Second, Ukraine’s exports represented less than 2% of world production ( Figure 8 ). So even if Ukraine ceased all its corn exports to the world, world supplies would hardly be affected. United States dollar-oriented prices, specifically, should certainly not be affected in the least, as the U.S.
imports virtually no corn from the rest of the world.
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Page 12

Figure 8 : Ukraine exports relative to world production and imports/trade.
1,000,000
900,000
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0
2008 2009
World Production
2010 2011
World Imports
2012 2013
Ukraine Exports
2014
What appears to have happened is that traders, not thinking or knowing about the actual data above, just felt that
Ukraine, which is erroneously seen as a large corn exporter, just must affect global markets. Traders then used that “news” as a catalyst to make trades and drive prices higher. The news media jumped on board with headlines such as “Wheat, Corn Prices Surge on Ukraine Crisis” (Wall St. Journal, March 3 rd , 2014).
It did appear as though prices around the world were responding to the perceived Ukraine problem in early
March. But as time progressed, the media continued to claim that the Urkaine situation was the driver, even as it became more apparent that it likely was not. During each successive period of price surges in U.S. dollar corn, prices in other countries seemed to move in line with U.S. prices less and less ( Figure 9 ). During the initial
February 27 th -March 6 th period of surging U.S. corn prices, for example, corn prices in other currencies rallied in tandem. But by the April 22 nd to April 29 th time period, most foreign corn prices did not rally along with U.S.
prices, with some corn prices falling. This suggests that at that point the rest of the world did not see Ukraine as the immediate driver of corn prices, yet the American media was reporting that “Trouble in Ukraine Lifts Prices of Corn, Wheat ” (Yahoo Finance, April 22nd 2014). In other words, it is more a matter of perception than fact, and that perception changed from country to country.
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Page 13

Figure 9 : 2014 Corn prices in different currencies and from different countries. The shaded areas highlight the key U.S. dollar rallies seen to be associated with the Ukraine crisis.
1.34
1.29
1.24
1.19
1.14
1.09
1.04
0.99
0.94
Jan-14
Ukraine US
Feb-14
France Brazil
Mar-14
Japan
Apr-14
Hungary Argentina
May-14
China India
There are also reasons to believe that the overall rise in U.S. corn prices throughout early 2014 were not even due to the Ukraine crisis, as the upward move looked to be wider than a corn-specific or Ukraine-specific event. This is because agricultural commodities as a group rallied in the winter and spring of 2014. Sorghum, cocoa, coffee, cotton, sugar, tobacco, oranges and peanuts all rose in the spring of 2014. Ukraine does not produce most of these crops, so there was no reason for risks to world supply due to Ukraine tensions to be the reason for their rally.
More likely, the early 2014 agriculture rally was just a bounce from the lows hit during the sell-off throughout
2012 and 2013. At the least, it might have been the excuse that implemented the bounce.
Ukraine’s corn production and exports did in fact fall from the prior year. However, by the time of harvest, news in the corn world had been re-focused on other perception-oriented stories. Thus, instead of corn prices rising as a result of the reduced Ukraine exports as expected in March, they ultimately ignored Ukraine and fell 30% by the end of Ukraine’s reduced harvest. In the end, the Ukraine “news” was no news at all, even though the “fears” came true. Instead, it was merely a temporary excuse traders used to give corn a fleeting bounce from it’s previous fall. By summer, traders had moved on to newer news to be falsely excited about.
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Page 14

Confusion about Oil Prices in 2014
The oil price collapse caught virtually everyone—including GROWMARK Research—by surprise. But now seemingly every analyst is going out of his way to explain why it is so very logical that oil prices should have been expected to fall. The problem is that most of their explanations do not add up, as they run against the laws of both economics and the nature of markets in forecasting the future.
The data initially cited as the catalyst for the fall of oil prices were reports of German GDP coming in lower than expected. Lower GDP was held to be a sign that Germany would “demand” less oil in the near future. However, if one calculates how small is the 0.5% reduction in Germany’s expected GDP growth rate, compared to global GDP, it becomes clear that Germany’s hypothetical reduction in oil usage would be negligible. Yet this fraction of a fraction of a percent reduction in demand is held to have knocked oil prices off a cliff. Prices had already fallen over 20% even before this news came out. Certainly, on reflection, we can’t be asked to believe that such an unremarkable decline in global GDP growth and oil usage was responsible for a 55% fall in oil prices—especially since such GDP revisions take place in many large countries every year without affecting oil prices at all.
Subsequently, analysts offered other explanations as well. The most common of these is the argument that the shale revolution, resulting in an explosion of natural gas production, would naturally cause competing oil prices to fall. Indeed, this increase in supply could result in less usage or less spending on crude oil; but the fact is that the shale revolution did not just begin in July 2014 when crude prices began their fall. It has been going on for years, and the world has been intently watching the dramatic increase in natural gas over the last five years as crude oil rose and then remained near its highs. Crude oil investors kept buying crude oil and kept the price high for many years while they were well aware of the increase in competing energy sources. So clearly that news was not what was driving crude oil suddenly lower.
Another major explanation offered for crude’s decline is the supposed reduction in global demand due to slowing economies. This argument is invalid for several reasons. First is the fact that slowing economies still use the same or almost the same amount of crude oil as before; but they just spend less money for it (remember the mainstream definition of demand is the usage of the product, not the spending of money to purchase it). The EIA forecast for crude oil demand (consumption) is that it will in fact increase, not decrease. Because of this last fact, analysts note that the increased demand will be less than previously expected (but not an outright reduction).
But as with the German GDP argument, if one does the math it is obvious that the magnitude of the reduction in increased demand due to slower growth amounts to maybe a percent or so. That less than previously expected growth in demand can not explain a fall in prices of 55%. After all, the total demand would still be higher than it is currently.
Even though those economists who draw the supply and demand graphs create crude oil supply and demand numbers that are not quite identical ( Figure 10 ), true crude oil usage must be virtually identical with supply.
This is because people cannot use (i.e., consume or demand) what has not been produced, and, as data show they will use all crude oil that is produced; supply will equal (physical) demand. This is especially true since there are virtually no stocks of crude oil (only minor stocks that remain almost unchanged from year to year). Therefore, crude oil “demand”—as it is defined by mainstreamers—is really just crude oil supply; changes in demand stem directly from changes in supply, not from some supposed want or need to use more or less crude oil. So all crude oil produced will be used. The question, again, is only one of how much will be spent purchasing the production.
Thus, true demand consists of the amount of money spent, not the number of units purchased.
Page 15
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Figure 3 shows us that by mainstream economists’ own calculations of crude oil supply and demand—which is what the chart is—the growth of the two are very stable. There is nothing about the evolution of what they call demand that shows a decline. The very small amounts that their demand (estimate) oscillates around supply could not be responsible for 50% movements in oil prices. Besides being mathematically impossible, if this were the case it should be expected that prices would often move as much as 50% every year when supply and demand are experiencing their very slight movements above and below the other.
Figure 10 : Formal (mainstream) supply and demand for crude oil.
110
105
100
95
90
85
80
75
70
65
60
2000
Supply
Demand
2002 2004 2006 2008 2010
Forecast >
2012 2014
There is, though, one mainstream argument used to explain falling crude oil prices that does make sense: that the rising dollar has put a damper on crude oil demand. This is plausible, since crude oil—which is priced in U.S.
dollars—would become more expensive to foreign buyers. The dollar is known to have a strong relationship to crude oil, and the dollar did suddenly take off in July of 2014 when crude prices began plummeting. However, the dollar has risen 10.5%, while crude oil has fallen 55%. If crude oil is now 10.5% more expensive to foreign buyers, they might want less of it, but only about 10.5% less at most (since all buyers are not foreign buyers). In any case, total usage of crude oil should not decline as crude becomes more expensive because of the fact that the oil is still needed; it should just have less money spent on buying it. If anything, foreign buyers might buy less while domestic buyers are able to buy more, due to the reduced number of foreign bidders.
A Better Explanation
The fall in crude prices did not come from reduced physical demand for oil by global consumers, but instead from reduced monetary demand by Wall Street firms. Wall Street banks and hedge funds send large volumes of money in and out of the commodity markets in different years as part of their investment strategies. Since the stock and bond market together have a value of over $60 trillion, if even a tiny fraction of that investment money is redirected to the $1 trillion commodity market, it represents a very large sum that can double and triple commodity prices.
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Page 16

Figure 11 gives some context to these numbers. It shows the volume of money spent by various futures market participants, as well as the crude oil price. The blue section labeled Financial Money Flow , which represents Wall
Street crude oil spending, averages about 65% of all spending in that market, and periodically reaches 75%.
Therefore, changes in the volume of Wall Street spending have a huge effect on prices. It’s clear from the chart that, in 2008 and over the last six months, crude oil prices collapsed when Wall Street reduced its spending in the crude oil market. Wall Street’s rate of spending decreased first, i.e., before that of other categories of spenders, and by the sharpest amount (the slope of the blue is much steeper than that of the green or red).
Figure 11 : Levels of crude oil spending in three categories vs. crude oil price.
$140
$120
$100
$80
$60
$40
$20
$-
2007
Financial Money Flow
Nonclassified Purchasers
Commercial Money Flow
Crude Oil Price $/Barrel
$200
$150
$100
$50
$0
2008 2009 2010 2011 2012 2013 2014
Figure 12 shows the Wall Street effect from a different view. When Wall Street focuses on the commodity markets, it invests not just crude oil but in commodities broadly. This is why most commodities tend to have the same price pattern over the long term. Figure 5 shows the GROWMARK Commodity Index (GCI)—which weights each commodity equally—with crude oil prices laid over it. Since most commodities tend to move together over time, it is no surprise that the evolution of crude oil prices since 1999 is similar to the composite of the other commodity prices.
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Page 17

Figure 12 : Crude oil price vs. the GROWMARK Commodity Index.
2.8
2.3
1.8
1.3
0.8
0.3
-0.2
-0.7
-1.2
1999
GCI
Crude Oil Price
2001 2003 2005 2007 2009 2011 2013
The chart shows that commodities as a whole have been falling since early 2011 (i.e., Wall Street money has been decreasing since 2011). But crude oil prices have been trading sideways without actually selling off. In July of this year, however, oil prices began catching up with the downward trajectory of other commodities—they were simply the “last man standing.”
In sum, crude oil prices did not fall due to changing economic growth forecasts, reduced demand, or even the rise of natural gas supplies. It fell because Wall Street decided to leave the commodity markets. It is not clear why
Wall Street stayed so much longer in crude oil than in other commodities, especially given the shale revolution.
(Indeed, this revolution in shale prices should result in investors’ spending less on crude oil.) But whatever the particular explanations of the timing, what is clear is that reduced spending of dollars in the domestic oil market was the proximate cause of the reduction in oil prices.
None-the-less, news articles on crude oil are released every day that attempt to explain why prices fell and why they should now rise to $200 or fall further to $10 due to supposed physical supply and physical demand changes, which are in reality hardly changing at all—at least they were not before prices fell. Every day oil experts explain in the news how the big move up or down that day is due to expected supply changes being a hair more or hair less than previously expected. None of these subtle changes are the reason for oil voliatily. Just about every single news article published on oil prices since the price decline began has been meaningless and has had nothing to do with the price of oil, because they don’t discuss the large volume of money and spending that left the market while physical supply and physical demand remained rather unchanged. In this case, the news is merely a distraction and a fantasy, not a cause of any kind.
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Page 18

Money Flows Exacerbate the Price Response to News Reports
Money flows do not always outright deceive and mislead. They can also merely distort the (appropriate) market response to the news. Consider Figure 13 . It shows the corn price response to monthly USDA crop reports/forecasts. Each individual black line marks the range of the price movement from the day before the report to two full days after the report (the approximate amount of time the market usually fully digests news).
The range of the price reaction—the length of the black lines—to the news is dramatically larger after mid-2006
(to the right of the red horizontal line), when large Wall St. money flows decended upon the corn market and pushed prices higher. Prior to mid-2006 the average corn price response to USDA reports was a 5.3 cents move.
After mid-2006 it was 16.8 cents, or more than three times greater. By contrast, price responses to news reports were much smaller than even the 5.3 cents during the gold standard period of the 1950s and 1960s, when prices hardly moved.
Figure 13 : The range of corn price movements (the length of each black line) in response to USDA crop reports before and after Wall St. money flows entered the corn market.
$6.90
$5.90
$4.90
$3.90
$2.90
$1.90
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Was there extraordinary news that came out during the post mid-2006 period justifying dramatically higher prices? No. The sum of the USDA crop reports between mid-2006 and mid-2008, like the larger 2003-2008 period above, was that production increased by 13% and stocks were flat. The sum of the reports of increases in supply that totaled 13% over that time period should have sent prices lower over those years—and would have, absent new and additional money—not driven them 180% higher. Additionally, many of the largest upward price moves on the chart occurred in mid-winter when crop forecasts were unchanged from the prior reports. In sum, prices went higher only because more money flowed into the corn market.
The range of price “responses” to crop forecasts in recent years of strong money flows should be distinguished from price responses to major production and supply changes during non-money-flow years. For example,
Page 19
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consider Figure 14 , which shows the price response in late 1995 and early 1996 to forecasts of sharp reductions in production levels. With no additional money in the market, prices rose to ration supply by way of the same quantity of money covering less supply. As crop forecasts (news reports) came out showing diminishing supply, traders could not magnify the price moves by investing new quantities of money, since they had no new and additional money. The result during this time of severe changes in the fundamentals was price responses to the crop forecast announcements that were—in contrast to those of money flow years—very small. The lesson here is that if production and supply are not changing significantly, large price swings and volatility are monetary (i.e.
spending) phenomena, not responses linked to the current news.
Figure 14 : The range of price movments in response to USDA crop reports during a period of short corn supply.
$6.90
$5.90
$4.90
$3.90
$2.90
$1.90
Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01
Figure 15 shows that during periods when additional money flows do not enter the market at high rates, prices necessarily move in (opposite) proportion to supply changes.
4 On the scale, the closer the bar is to a level of 1 the more the price response is in exact proportion to the change in supply. A ratio of 40 means that prices moved
40% in response to a 1% change in production, instead of the 1+% change in price that would be dictated by the supply change alone. It is only money flows that can cause the price to change in excess of the inverse of the change in supply.
5
4
In actuality, prices moved just slightly more than inveresely, as the chart shows, because there are still some very small fluctuations in spending year over year by commercial/traditional market participants based on their existing stock of money.
5
Unless production changes are minute while the change in spending remains relatively normal, leaving spending changes to look large relative to a virtually unchanged supply.
Page 20
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Figure 15 : The ratio of price changes to production changes. (A ratio of 2 [2 to 1] means prices moved 2% in response to a 1% change in production).
40
35
30
25
20
15
10
5
0
Maximum Ratio
Average Ratio
Non-Money-Flow Years Money-Flow Years
(1971-79, 2006-12)
Money flows also cause prices to generally fall less and rise more than they otherwise would simply because the increasing volume of money acts as a price floor on the market. When news comes out that sends prices lower, prices fall a moderate amount on average. But when news comes out that implies prices should go higher, prices rise on the good news more than they fall on bad news.
The sum of all the price moves responding to “positive” reports (such as reduced supply that would send prices higher) over many years is greater than the sum of all the price moves responding to “negative” reports (that would send prices lower). But negative reports are more common than positive reports, since over time supply increases. So why does the market react more strongly to positive reports? Just because there is a tendency for prices to rise in general, since money is flowing into the market over time. New money tends to be allocated during times of positive reports, pushing prices higher. But when negative reports come out, money is not taken away; it stays in the market and prevents prices from falling very much. Were money flow not a factor, prices would respond only in accordance with expected changes in supply as shown in Figure 2, and would thus fall over time as supply increased.
Observers never seem to question why prices fall, say 0.5%, on average, for every 1% rise in supply, but rise 2% on average for every 1% fall in supply. They blindly accept price moves as being “the market’s assessment,” even though the market’s assessment is illogical according to both mathematics and economic theory 6 .
Figure 16 shows how prices responded more positively to good news than bad between mid-2006 and the end of
2008, the period of the strongest money flows. The average upward price response to USDA crop forecasts was
19.2 cents while the average downward price response was 11.3 cents. The sum of the news over this time period was that production and supply were increasing significantly (i.e., bad news), which would portend lower prices, not higher ones.
6
Observers pick and choose pieces of economic theory without considering all aspects of theory as a whole.
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Page 21

Figure 16 : The average price response to USDA crop forecasts to both bullish news (green) and bearish news (red).
0.18
0.13
0.08
0.03
-0.02
-0.07
-0.12
Average Upward Price Movement, Mid 2006-2008
Average Downward Price Movement, Mid 2006-2008
If prices had truly been responding to the news of changes in supply over the period in question, the average negative price response in Figure 13 (the red bar) would be much larger than average positive price response, since prices would have fallen over this period as supply increased. The fact that the average downward price movement is not larger shows that market participants, always eager to buy with their new money, were generally responding only moderately to negative news, then soon forgetting negative news to instead focus on resuming their buying once negative news was replaced by no news or positive news.
At the same time, the market responded to the few eruptions of good news occurring in the midst of on-going bad news with a buying spree—an out-of-proportion response. What happened through the time period overall was that the volumes of money flowing into the corn market lifted the price of corn, thereby overwhelming any otherwise downward movement caused by negative news. It is somewhat analogous to a rising tide lifting a boat that is slowly sinking, where the boat rises faster from the tide than it sinks from the hole in it.
It is also similar to what happened in the late 1990s with the NASDAQ stock market bubble. 1997, 1998 and 1999 were years filled with terrible news, including the Asian currency crisis, the Russian debt crisis, the Brazilian financial crisis, the collapse of the hedge fund Long Term Capital Management, and the threat of an “overheated”
U.S. economy, accompanied by rising interest rates. The market sold off during the days or weeks these headlines were front-page, but then turned and raced higher only a few days or weeks later. Between news reports, the
NASDAQ continued making all-time highs. The sum of the news was that the world economy was in terrible shape and getting worse, but the NASDAQ shrugged it off and rallied 327% higher over that three-year period that the world looked bad, pausing only to sell-off briefly during windows of bad news announcements. It was only the sheer volume of money flowing into the NASDAQ that made it go higher while the economic outlook worsened; the rising NASDAQ had no relation to the news or the fundamentals.
In both the corn and NASDAQ markets, it was not the news release that made prices rise; it was that the news release occurred while prices were rising. Market participants looked at the price action and assumed that the market must really be reacting strongly to the news—news that should have sent prices in the opposite direction.
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Page 22

Money Flows Have a Life of Their Own
The central bank creates money at a faster pace than people and businesses can create goods and services. The growth of money in the economy will therefore inevitably raise prices. As and when money flows into commodity and other asset markets specifically—even if the flows are sporadic and uneven in magnitude through time—it will push prices higher, since the money must go somewhere. It is mathematically impossible for money to enter a market without pushing up prices. Money flows are a driver of prices unrelated to and independent of any other factor(s). They are the embodiment of additional demand—demand is monetary, not physical.
When money flows slowly and evenly into consumer goods markets, people accept that prices are rising due to inflation. But when the money flows suddenly and heavily into commodity markets, market participants do not think of money flows per-se, but believe that the rising prices must be because of some non-specific “increased demand.” They believe rising prices constitute something related to the fundamentals of agriculture, metals, or energy. But that is not usually the case. In recent years, money has flowed into the commodity markets as investment funds by Wall St., which, in conjunction with the central bank, created more and more money through time, necessarily inflating prices. Money flows, therefore, move prices regardless of what the news is or whether there is any news at all.
Conclusion
News can not raise prices without being accompanied by increased spending. Only new and additional money can push prices higher over time while supply is growing. But when people see prices going higher, they assume that the news is the cause, when, instead it is the inflow of money. News does not create money or cause it to be spent, but traders tend to use news reports as catalysts for engaging in planned additional spending.
Money inflows also exacerbate legitimate price responses to news. They cause increased volatility of whatever price movements would otherwise take place. Historically, the less money flowing into a market, the less volatile are prices. Money flows are driven largely by Wall St. and can not be anticipated.
Analysts and forecasters should be aware of these factors and understand that 1) over time, it is only new and additional money that makes prices go higher; and 2) during times of heavy money flows the news and the fundamentals that people assume are driving prices are usually not. This was the case during the 1970s as well as in the 2000s/2010s in the commodity markets. Though people point to causes such as OPEC production cuts,
Soviet wheat deals, China demand, growing emerging markets and world hunger to explain rising and volatile commodity markets, the data have shown that none of these things are determining factors.
Instead, the driver of ever higher prices is large sums of money entering commodity markets from outside institutions and other financial markets. Though money flows are not part of commodity basics, they are most definitely part of the fundamentals—probably the most important one.
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Page 23

© 2014 GROWMARK, Inc.
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Page 24