News, Money and Prices

GROWMARK Research February 25, 2015

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News, Money and Prices

How Money Flows Distort Our Perceptions of News Reports

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.


Introduction

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.

1While 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 changesin 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 betweenspending and physical demand and trained themselves to focus only on physical demand without considering its driver. Physicaldemand 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 inmonetary spending change by very large degrees during certain periods.


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.

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

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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).

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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.

2See the link to the paper on ethanol on the last page of this document.


Figure 3: Total futures market spending since 1986 on the commodities listed in the chart.

Source: CFTC, authors’ calculations

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).

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

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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 inthe 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 slowingbecause prices were high. …Money.cnn.com

[But on July 3rd, just prior to the start of the price collapse, Bloomberg news stated: “Crude oilrose 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 yearsto come, just as crude oil reached new highs. The IMF apparently did not believe high priceswould 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 UniversityAgriculture News

Precious metals as a group: Poor auto sales (platinum and palladium are used in themanufacture of catalytic converters), and the energy crisis. …Palladiuminvestingnews.com

Agriculture prices in general: High prices choking off demand (prices went down because theywent up). …ABC News

Corn, soybean, and wheat prices in particular: Favorable weather led to a greater productionthan 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 soybeansproduction was actually expected to fall, not rise (which should send prices higher, not lower).]


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.



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.

3This 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.


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.

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

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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.

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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Figure 7: Evolution of world crude oil 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.


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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Figure 8: Ukraine exports relative to world production and imports/trade.

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 3rd, 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 27th-March 6th period of surging U.S. corn prices, for example, corn prices in other currencies rallied in

tandem. But by the April 22nd to April 29th 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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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.

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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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.


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.

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 re-

directed to the $1 trillion commodity market, it represents a very large sum that can double and triple commodity

prices.

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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.

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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Figure 12: Crude oil price vs. the GROWMARK Commodity Index.

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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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.

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,

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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.

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

4In 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.

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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).

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 theory6.

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.

6Observers pick and choose pieces of economic theory without considering all aspects of theory as a whole.

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Figure 16: The average price response to USDA crop forecasts to both bullish news (green) and

bearish news (red).

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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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.


This paper is the fifth in a series of five:

“4 Reasons Why Ethanol Doesn’t Drive Corn Prices,” January 2013

“Demand from China: Fact or Fiction?” August 2013

“Food, Hunger and Commodity Prices,” December 2013

“The Stocks-to-Use Ratio: Is it Meaningful For Price Determination?,” June 2014

“News, Money, and Prices,” June 2014

Katherine Daugherty is a Sr. Market Research Analyst with GROWMARK. Contact

[email protected]

Kel Kelly is in charge of GROWMARK’s Economic and Market Research. Contact him:

[email protected]

About GROWMARK

GROWMARK is a $10 billion regional agricultural cooperative based in Bloomington, Ill. GROWMARK is

owned by local member cooperatives and provides those cooperatives and other customers with fuels,

lubricants, plant nutrients, crop protection products, seed, structures, equipment, and grain marketing

assistance. In addition, GROWMARK provides a host of services from warehousing and logistics to

training and marketing support. The GROWMARK System serves customers in more than 40 states and

Ontario, Canada.

News, Money and Prices

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