This is a real eye opening article that came in recently.

Here are some important points.

Good morning and thank you, Mr. Chairman and Members of the Committee, for the invitation to speak to you today. This is a topic that I care deeply about, and I appreciate the chance to share what I have discovered.

I have been successfully managing a long-short equity hedge fund for over 12 years and I have extensive contacts on Wall Street and within the hedge fund community. It’s important that you know that I am not currently involved in trading the commodities futures markets. I am not representing any corporate, financial, or lobby organizations. I am speaking with you today as a concerned citizen whose professional background has given me insight into a situation that I believe is negatively affecting the U.S. economy. While some in my profession might be disappointed that I am presenting this testimony to Congress, I feel that it is the right thing to do.

You have asked the question “Are Institutional Investors contributing to food and energy price inflation?” And my unequivocal answer is “YES.”

So, how do we explain such a spectacular rise in commodity prices without the queues and rationing? Michael Masters answered,

What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets

Just who is this “new category” of market participants? Is it China and India? No! The rising demand of these two giant nations had been gradually brewing and simmering over the past decade and will continue to the next decade and beyond. Their demand are hardly a shock.

Institutional Investors. Specifically, these are Corporate and Government Pension Funds, Sovereign Wealth Funds, University Endowments and other Institutional Investors. Collectively, these investors now account on average for a larger share of outstanding commodities futures contracts than any other market participant.

What happened was that these institutional investors hoarded commodities through the futures market, affecting futures price, which in turn affected the spot prices (i.e. the real world market price). The spot prices are the prices that we all face in our daily life.

The value of assets devoted to commodities by these Index Speculators grew from just US$13 billion in 2003 to US$260 billion as of March 2008. Over these 5 years, the prices of commodities grew by an average of 183%. In 2003, they were small fries in the commodities futures market. Today, they are the largest force in the market.

To compound the effect of Index Speculators on commodity prices, it must be noted that the commodity futures markets are much smaller than the capital markets. For example, it is 240 times smaller than the global equity market. Thus, every dollar on commodity futures has a much greater impact on prices than the same dollar on equities. To compound the problem even further, it was observed that their demand increases prices, which in turn increases demand even more. That is, hoarding begets more hoarding.
This last one is what amazed me. I did not expect the commodity futures market to be THAT SMALL by comparsion. Just a few % allocation of these insitutational investors' portfolios would make a huge different in the commodity prices.

I feel really sorry for these starving Africans now. Their misery is caused by the rich people who are looking to protect their massive wealth by allocating a portion of it to the commodity market, which is by history, uncorrelated to the equity market. So we can announce that diversification do kill people.