How much are speculators adding to food and fuel inflation? A lot, says one trader. One of the most interesting pieces of testimony I have read in a long time came today from Michael Masters, Managing Member of Masters Capital Management.

He was in front of the Committee on Homeland Security and Government Affairs of the U.S. Senate. Mr. Masters has been a long-short equity hedge fund manager for over 12 years. Here's what he had to say:

1) Commodity prices have increased more in the aggregate over the past five years than at any other time in U.S. history; specifically assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008;

2) The primary increase in demand for commodities has come from Institutional Investors, specifically pension funds, sovereign wealth funds, university endowments, and others, whom Master collectively calls Index Speculators. This group now accounts for a larger share of outstanding commodities futures contracts than any other market participant.

3) These Speculators allocate a portion of their portfolios directly to the commodities futures market, and behave differently than traditional speculators; specifically, they buy with little regard for price and tend to be mostly buyers, not sellers.

4) While much of the rise in the price of oil has been attributed to increased demand from China, speculators are responsible for at least an equal increase in demand; specifically, annual Chinese demand for oil has increased by 920 million barrels over the last five years but Index Speculators demand for petroleum futures has increased by 848 million barrels

5) While the rise in corn if often blamed on ethanol production, Speculators have stockpiled over 2 billion bushels of corn futures in the last five years, enough to fuel the entire U.S. ethanol industry for a full year.

Masters concludes with this analogy: "Think about it this way: If Wall Street concocted a scheme whereby investors bought large amounts of pharmaceutical drugs and medical devices in order to profit from the resulting increase in prices, making these essential items unaffordable to sick and dying people, society would be justly outraged."

Masters urges Congress to 1) prevent pension funds from investing in commodities, and 2) close loopholes that allow banks to get around limits on speculative positions.

Mr. Masters assumes, as many do, that supply is adequate--which is debatable, particularly from oil (the world produces 85 million barrels a day and seems to be having a tough time increasing supply). And we certainly know that demand has been increasing from consumers, not just from institutional investors. So his argument is certainly far from flawless.

But Masters is one of the first to put real numbers behind the idea that speculation is a major force in commodity price increases.

Here is the full testimony.

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