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Apr-22-2008The Food Chain Price Volatility Adds to Worry on US Farms(topic overview)
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Until recently, that system had worked well for generations. Since 1959, grain producers have been able to hedge the price of their wheat, corn and soybean crops on the Chicago Board of Trade through the use of futures contracts, which are agreements to buy or sell a specific amount of a commodity for a fixed price on some future date. The exchange has offered another tool: options on those futures contracts, which allow option holders to carry out the futures trade, but do not require that they do so. Trading in options is not as effective a hedge, farmers say, but it does not require them to put up as much cash as is required to trade futures. These tools have long provided a way to lock in the price of a crop as it is planted, eliminating the risk that prices will drop before it is harvested. With these hedging tools, grain elevators could afford to buy crops from farmers in advance, sometimes a year or more before the harvest. That was yesterday. It simply is not working that way today. [1] The futures trading commission is scheduled to meet with farmers, food processors and investors Tuesday to discuss the reasons for the turbulent markets. Groups representing farmers and food producers have asked regulators to consider limiting speculation to return predictability to the markets, which they say have been stoked for two years by profit-hungry investors. This month, corn futures have closed at an average of $5.80, more than 140 percent above the $2.38 prices recorded in April 2006, according to analysis of Chicago Board of Trade data by consulting firm DTN.[2] Farmers, ranchers and grain processors met with regulators in Washington to discuss the causes behind turbulent markets and historically high prices for wheat, corn and other foodstuffs. Food producers have complained in recent months that increased speculation by Wall Street investors has thrown off-balance the exchanges where they buy and sell crop futures.[3]
WASHINGTON (AP) - A government regulator says speculative trading is not the primary culprit behind surging prices of corn, wheat and other crops that have rattled farmers and food producers.[4]
Now consumers and Farm Belt market participants hurt by more-volatile prices are asking Washington to rein in increasingly powerful commodity investors. A hearing Tuesday in Washington before the Commodity Futures Trading Commission starts a new round of scrutiny into the popularity of agricultural futures, a once a quieter arena that for years was dominated largely by big producers and consumers of crops and their banks trying to manage price risks. [5] One measure of the farming industry's frustration is the overflow crowd expected at a public forum on Tuesday at the Commodity Futures Trading Commission in Washington. Interest is so high that the commission, for the first time ever, will provide a Webcast of the forum, which it says is being held to gather information about whether crucial markets for hedging the price of crops "are properly performing their risk management and price discovery roles."[1]
The U.S. Commodity Futures Trading Commission is meeting farmers and traders on Tuesday to discuss the jump in agriculture commodities' prices amid criticism from U.S. politicians and farming associations that speculators are behind the increase. It will say prices have been driven by robust demand, weather-related supply disruptions, the lowest inventories in 30 years, government trade restrictions and the impact of the weaker U.S. dollar, officials said. Bart Chilton, one of the four CFTC commissioners, said the data from the commission's economists showed that "at this time there is not a correlation between excessive speculative activity and prices".[6] Local grain elevators generally do not offer prices as high as distant futures markets, due to "price convergence" and "basis" issues. Space constraints make it impossible to explain these somewhat complicated concepts, but it is safe to assume farmers are not receiving the high, even record, prices some exchanges advertise. The higher and more volatile futures prices have caused the futures exchanges to raise their margin requirements--those funds held in reserve to cover price changes--to a point that they exceed users' abilities to pay. A handful of grain elevators have gone out of business when operators were unable to extend their credit lines to meet these margin calls. Given this highly volatile business climate, the Commodity Futures Trading Commission (CFTC) will convene a public meeting to discuss events affecting the agriculture markets on April 22. Topics will include the lack of convergence between the futures and cash prices, higher margin requirements and their effects on market participants, and the role of speculators and commodity index traders.[7]
The CFTC would not have scheduled the April 22 meeting if it wasn't "thinking" about doing something to regain some control many think the regulatory commission has lost. That "smells" like a rule change. potentially position limits on hedge funds. In the March 1 Pro Farmer, we expressed our concern that futures contracts have strayed from their original intent -- price discovery and a risk-transference tool for producers of the commodities represented by futures. When futures contracts were developed, it's doubtful anybody thought of commodity futures as an "investment."[8] I don't expect any action from the CFTC to immediately follow today's meeting, but I do expect the CFTC to stress the intent of futures contracts, to express concern over "commodity investment" (hedge funds, index funds and ETFs), and to look for market participants to provide support for the CFTC to regain (retake) some of the control it has lost over the commodity markets. What might they do? I wouldn't be surprised if CFTC eventually proposes position limits on the hedge funds, index funds and ETFs.[8]
The commission has invited 29 participants - ranging from the U.S. Federal Reserve to hedge fund managers, grain farmers, academics, cattle ranchers and even bakers - to make presentations. The meeting was organized after the CFTC received a flood of complaints earlier this year about price anomalies.[9]
Speculators such as hedge funds or pension funds are not responsible for pushing agricultural commodities' prices, including wheat and rice, to record highs, U.S. regulators will say this week.[6]
Mr Chilton said: "Market fundamentals appear to be functioning appropriately". He said the regulator was paying extra attention to the agriculture market as it was a cornerstone to American farmers. Walt Lukken, CFTC acting chairman, said: "Everyone agrees these are extraordinary times in the agricultural commodity markets, but there are varying opinions as to what's driving them." The regulator is under pressure from politicians after the prices of wheat, corn, soyabean and rice hit record highs this year.[6] A widely used measure of volatility showed that traders in March expected wheat prices to swing up or down by more than 72 percent in the coming year, three times the average volatility for that month and the highest level since at least 1980. The price swing expected in March for soy beans was three times its monthly average, and the expected volatility in corn prices was twice its monthly average. Those wild swings in expected prices are damaging the mechanisms - like futures contracts and options - that in the past have cushioned the jolts of farming, turning already-busy farmers into reluctant day traders and part-time lobbyists.[1] As the date for delivery approaches the futures price and the cash price should converge. That hasn't happened on several occasions in recent years, according to research by professors at the University of Illinois at Urbana-Champaign. Their research found that at times the futures price for wheat was 90 cents (U.S.) a bushel higher than the cash price on the last day of delivery. The same phenomena occurred in soybeans and corn.[9] Prominent media outlets have responded by devoting more time and space to farm-related issues. This combination of factors has helped shine a spotlight on the widening disparity between prices offered in the cash and futures markets in recent months. Farmers generally receive cash prices when they physically transfer their wheat, corn, beans, cotton and even livestock to local elevators, warehouses and auction barns--the daily spot markets in their communities.[7]
While higher prices would seem to benefit suppliers, the gains mean farmers have to put more money down to hedge themselves against future risks. Farmers use the futures markets to buy contracts to sell their crops at a specified price, avoiding potential drops in prices at a later date. They are required to put down a margin deposit of the contracts total value when they purchase the agreement. With the value of contracts rising to historic levels, some farmers have found themselves with more cash tied up in margin calls than their crop is worth.[2] Researchers have found that recently the market has behaved in an abnormal fashion and set two final prices for the same product. Typically farmers hedge their crop by employing futures contracts, which are essentially agreements to deliver a specific amount of product on a certain date at a certain price.[9]
Crops are not actually traded in futures markets; special contracts called "futures" are bought and sold there. These legally binding agreements specify prices and times when commodities will be transferred down the road.[7]
In July, 2006, soybean futures contracts expired at $9.13 a bushel, 80 cents higher than the cash price that day.[9] Back in 1988 when I first started on the floor of the Chicago Board of Trade as a rookie reporter for Futures World News, Ferruzzi was buying up all the soybean futures contracts it could and buying all the cash soybeans it could. It maxed out position limits. plus some. It owned a huge percentage of the cash beans, too. It was a "squeeze" in a futures market. long futures and a "controlling interest" in the cash market.[8] The CME Group, which runs the Chicago Mercantile Exchange and the Chicago Board of Trade, said average daily trading volume for all products in the first quarter increased 32 per cent year-over-year to a record 13.7 million contracts.[9]
Markets that offer futures are the Chicago Mercantile Exchange, the Minneapolis Grain Exchange and similar trading hotspots. Sky-high futures prices are at the center of media attention these days, and Americans may think all farmers are bringing home the proverbial bacon.[7] Trading on the Chicago, Minneapolis and Kansas City exchanges, together the world's largest agricultural market, has become so unpredictable the regulator, the Commodities Futures Trading Commission, is holding an unprecedented public meeting tomorrow in Washington to get to the bottom of the issues.[9] April 21 (Bloomberg) -- The U.K. derivatives industry lacks transparency and the regulator, the Financial Services Authority, needs a "strong effort'' to pursue market manipulation, the U.S. Commodity Futures Trading Commission's Bart Chilton said.[10] Commissioners from the Commodity Futures Trading Commission said current conditions can be explained by a host of factors that have driven demand for U.S. crops: a weak dollar, small inventories due to poor weather and higher transportation costs. In their opening comments to participants, the agency's four commissioners showed little enthusiasm for setting new restrictions on speculation to attempt to calm commodities trading.[3] NEW YORK, April 21 (Reuters) - The U.S. Commodity Futures Trading Commission said on Monday it imposed civil penalties on Alaron Trading Corp, a Chicago-based futures commission merchant, for failure to diligently supervise its employees. Alaron, which settled the charges, was ordered to pay a civil penalty and restitution totaling $299,000 and strengthen its supervisory controls, CFTC said in a release.[11] The Commodity Futures Trading Commission (CFTC), the government agency which oversees the futures markets, is hosting a roundtable discussion Tuesday to look into the concerns whether agriculture markets are functioning as designed with regard to risk management and price discovery.[12] An official at the Commodity Futures Trading Commission said commodities markets are functioning properly, according to an agency staffer. Bart Chilton, one of the CFTC's four commissioners, speaking in London this weekend said that the conditions are due to a host of factors, including weather conditions that have shrunk harvests, smaller grain inventories and the declining value of the dollar.[4] Questions should be sent to [email protected] or send statements to: Secretariat, Commodity Futures Trading Commission, 1155 21st St., Washington, D.C., 20815. CFTC spokesperson R. David Gary said no official action will occur at the panel; rather it is a forum to allow industry participants on all sides to voice their opinions.[12]
An official at the Commodity Futures Trading Commission said Monday commodities markets are functioning properly, despite almost daily jolts in prices for foodstuffs.[2] The Commodity Futures Trading Commission issued and settled charges against Alaron Trading Corp. Monday, fining the Chicago-based firm almost $300,000 for not properly supervising brokers dealing with customer accounts.[13]
The futures trading commission is scheduled to meet with farmers, food processors and investors Tuesday to discuss the reasons for the turbulent markets.[4]
Mr. Grieder's days on the farm in Carlock, Ill., are getting even longer. He now has to keep a closer eye on the derivatives markets in Chicago, trying to hedge his risks so that he knows how much he will be paid in the future for crops he is planting now. The financial tools he uses to make such bets are getting more expensive and less reliable. In what little free time he has, Mr. Grieder attends Illinois Farm Bureau meetings to join other frustrated farmers who are lobbying officials in Chicago and Washington to fix a system that was designed half a century ago to reduce uncertainty for food producers but is now increasing it.[1] The term "small business owner" fits most farmers better than almost any other because no matter how straight the crop row, no matter how tall it grows, if the farmer cannot manage risk and successfully market the harvested crop, then all the work is for naught. While running a small business is an ongoing fact of life for farmers and ranchers, other events such as the development of the ethanol industry have transpired to raise the public profile of U.S. agriculture. As farmland values escalate and prices for food and other items rise, Americans several generations removed from family farms and ranches want to know more about modern agriculture and the sources of the food they eat.[7]
With institutional investors pouring money into commodity markets at a time of stock market uncertainty and other factors, farmers have charged that speculation is driving up the cost of basic crops and making it harder for commercial buyers and sellers of grain to use the exchanges as a tool for limiting their exposure to price volatility.[4] "To think you wont have senators and congressmen blaming high prices of things on speculators is naive." With institutional investors pouring money into commodity markets at a time of stock market uncertainty, farmers have charged that speculation is driving up the cost of basic crops and making it harder for commercial buyers and sellers of grain to use the exchanges as a tool for limiting their exposure to price volatility.[2]
The additional costs that stem from volatility in grain prices - higher crop insurance premiums, for example - are not just a problem for farmers. "Eventually, those costs are going to come out of the pockets of the American consumer," said William P. Jackson, general manager of AGRIServices, a grain-elevator complex on the Missouri River. [1]
Some grain elevators are coping with the volatility and hedging problems by refusing to buy crops in advance, foreclosing the most common way farmers lock in prices.[1]
Increasingly - for disputed reasons - grain futures are expiring at prices well above the cash-market price. When that happens, farmers or elevator owners wind up owing more on their futures hedge than the crops are worth in the cash market. Such anomalies create uncertainty about which price accurately reflects supply and demand - a critical issue, since the C.B.O.T. futures price is the benchmark for grain prices around the world.[1] Futures, for example, are less reliable. They work as a hedge only if they fall due at a price that roughly matches prices in the cash market, where the grain is actually sold.[1]
Local cash markets traditionally look to futures markets for "price discovery." Futures markets initially were designed as a price discovery mechanism for farmers looking to sell the fruits of their labors.[7] There was no (or very small) supply available in the cash market and the owner of the cash commodity wasn't hedging in futures, it was buying futures to push prices up even more. Think the Hunt Brothers in the silver market in the 1970s. they did the same thing.[8]
The problem many times is that the futures price and the physical price of the commodity would not converge, or meet at a similar price, at delivery, skewing price discovery.[12]
Prices of broad commodity indexes have climbed as much as 40 percent in the last year and grain prices have gained even more - about 65 percent for corn, 91 percent for soybeans and more than 100 percent for some types of wheat. This price boom has attracted a torrent of new investment from Wall Street, estimated to be as much as $300 billion. Whether new investors are causing the market's problems or keeping them from getting worse is in dispute.[1] TORONTO and NEW YORK - Ian Wishart grows beans, corn and canola on his farm near Portage la Prairie, Man., and watches commodity markets closely to see what he'll get for his crops. He's finding it harder to follow the markets these days because the prices don't always make sense. "Nowadays it's not sending the same market signals that it used to," Mr. Wishart said. He blames investment funds for distorting prices.[9]
Many farmers say the price problems stem from a surge in investment fund activity.[9]
In January, the CFTC said investment funds accounted for 40 per cent of the wheat trading.[9] Wheat trades within a set price range, which for years was 30 cents. That meant whenever the price rose or fell by 30 cents, trading locked at that level.[9] Trading became so frantic all three U.S. exchanges had to halt wheat trading for more than a week because the daily price limit was being reached at opening.[9] Price limits and margin levels e. Several industry participants have called for moving to cash-settled index contracts, such as those used by the Minneapolis Grain Exchange for hard red spring wheat.[12] "These historic market conditions, particularly in wheat and cotton, require the CFTC to hear firsthand from participants to ensure that the exchanges are functioning properly to discover prices and manage risk," said CFTC acting chairman Walt Lukken.[9]
The expansion of financial investors in commodity markets has raised the risk of market abuse and failure, the FSA said in March 2007. "Those largest market participants in the derivatives industry can actually impact what consumers pay for goods -- everything from how much motor fuel to the price of bread costs,'' Chilton said.[10] "I am generally concerned about a lack of transparency and the need for greater oversight and enforcement by the FSA of the derivatives industry.'' The London-based FSA in January said it decided against publishing the holdings of investors such as hedge funds in London's commodity markets, citing costs. The CFTC publishes a weekly report showing such holdings in the markets it oversees.[10] The FSA has at least 25 people monitoring the commodities markets, according to La Thangue. Commodity investments, including those from hedge funds, rose by more than a fifth in the first quarter to $400 billion, Citigroup Inc. estimated April 7.[10] "The hedge funds swing up and down with the technical signals in the markets, and our markets aren't deep enough to absorb that," said Roy Huckabay, director of market research for commodities at the Linn Group in Chicago.[9]
Mr. Grieder's crop insurance premiums rise with the volatility. Does the cost of trading in options, which is the financial tool he has used to hedge against falling prices. [1] In March, corn and canola more than doubled in price year-over-year on high volumes. While farmers like higher prices, the volatility adds to their risk. It comes as many are facing steep increases in costs for fuel, fertilizer and chemicals.[9]
"Never before in history has there been a time like we've seen in the last eight or nine months," said Curt Denesiuk, director of commodity risk management for the Canadian Wheat Board, which sells nearly all wheat grown by Canadian farmers.[9] Farmers commonly are associated with the work of planting seeds, watching the skies, harvesting mature crops and a multitude of other chores. Monitoring the movement of commodity prices and knowing when and how much of the crop to sell also are essential components, though these tasks tend not to be as visible to family members, friends and neighbors not intimately familiar with the ways of farming.[7] For centuries commodity markets have been used by farmers and food companies as a valuable way to protect themselves against fluctuations in agricultural prices.[9] Mr. Wishart's frustration is being echoed across the agricultural sector as investors pour hundreds of billions of dollars into commodity markets. With prices for products swinging wildly this year, questions are being raised about whether the commodity markets are working properly.[9] To take an outsize position in any asset is my Fundamental right as is the obverse. It is this kind of fuzzy headed thinking that leads to losses in any sector. Someone will come to the rescue, preferably the FED or in this case the CFTC. The Futures markets are a messenger. Just because the message is one of higher prices [There is a powerful legitimate reason for this - Population growth, increased calorific mean consumption per person, bio fuels and a reversal of a three decade slump in Agri prices, cannibalisation of Agri land, and it is nonsensical and a non sequitur to target Investors who are reading the lie of the land. Its absurd.[8] "The futures market does not appear at all reflective of market fundamentals," wrote Mark Lange, who heads the National Cotton Council. He said that on one day in March the price of cotton soared despite a report from the U.S. Department of Agriculture indicating global cotton supplies had increased.[9]
The FSA relies too heavily on exchanges to regulate markets and there needs to be "greater oversight and enforcement,'' Chilton, one of four commissioners at the CFTC, said in e-mailed comments to Bloomberg today. Chilton was in London to discuss the mutual recognition of U.K. and U.S.-registered options and futures so they can be traded in both markets. "While I strongly support greater harmonization efforts, I will oppose any weakening of U.S. oversight in order to accommodate a less stringent regulator,'' Chilton said in his e- mail.[10] Representatives from the CFTC, futures exchanges, agriculture industry and investment firms will attend.[12]
We called the CFTC an "800-lb. gorilla" because of the way it has enforced the rules of futures trading in the past.[8]
The futures price can be higher or lower than the daily spot or cash price, depending on market expectations about crop sizes, weather and so on.[9] The discrepancies have frustrated many market players who don't know which price to rely on. Scott Irwin, one of the researchers, said it's not clear why convergence did not occur and there is no real pattern. He noted that the three most recent wheat contracts, some of the most volatile ever, converged normally. "At a minimum this period has exposed some cracks in the delivery for those contracts, and whether fixes itself or not in the short run, we need to take a careful look at what might be more robust systems in the future," Prof. Irwin said.[9] Most futures contracts are physically delivered, meaning someone who holds a position until delivery is responsible to either make or take a delivery of say, wheat or cotton, to close out the position.[12]
Fred Grieder, a farmer near Bloomington, Ill., has more to worry about these days than hard work, crops and rain. If the market for commodities futures turns the wrong way, he could be wiped out. [1] Senator Byron Dorgan recently said that commodities futures markets were suffering from "an orgy" of speculation. "This is a 24-hour casino with unbelievable speculation," he said.[6]
The investment community greeted the commissioners remarks with approval. Dennis Gartman, editor of a commodities letter for investors, agreed that there are multiple reasons for higher prices but speculation is not one of them.[2] Investment funds have been in commodities for decades but a key rule change by the CFTC a couple of years ago helped open the floodgates.[9]
The American Farm Bureau Federation will participate in the CFTC meeting to convey the concerns of farmers across the country. Regardless of the types of crops produced on farms near you, be assured Farm Bureau will continue to monitor this developing situation, urge the CFTC to be engaged, and speak out on behalf of U.S. farmers and ranchers.[7]
"I can't honestly sit here and tell you who is determining the price of grain," said Christopher Hausman, a farmer in Pesotum, Ill. "I've lost confidence in the Chicago Board of Trade."[1] WASHINGTON Federal regulators on Tuesday said placing tougher restrictions on agricultural commodity trading will not alleviate high and volatile prices in those markets, and could make matters worse.[3] Wheat prices have dropped to about $9 a bushel, but trading remains active.[9] The price of wheat, for example, soared as high as $25 (U.S.) a bushel in February, a fivefold increase from a year earlier.[9] Wheat has jumped by 144 percent from an average of $3.46 in 2006 to $8.45. Those prices have been passed on to food processors and consumers in the form of pricier ingredients.[2]
"Our economists have looked at all the data available. and there doesnt appear that any inordinate speculation has caused prices to move," said Commissioner Bart Chilton. [2] Chilton said: "Market fundamentals appear to be functioning appropriately." Walt Lukken, CFTC acting chairman, said: "Everyone agrees these are extraordinary times in the agricultural commodity markets, but there are varying opinions as to what's driving them."[12] The commission gave index funds an exemption to limits on commodity trading that applied to market speculators.[9] To unlock trading in February, the exchanges took emergency action and doubled the limit to 60 cents, with provisions to increase it further if needed.[9]
SOURCES
1. Price Volatility Adds to Worry on U.S. Farms - New York Times
2. Regulator says increased speculation is not behind surging commodity markets - International Herald Tribune
3. SignOnSanDiego.com > News > Business -- Regulators say limits on speculation could worsen markets
4. Regulator says increased speculation is not behind surging commodity markets | Markets | Market News | Canadian Business Online
5. Free Preview - WSJ.com
6. Regulator set to clear funds over grain prices
7. The Voice of Agriculture - American Farm Bureau
8. AgWeb Blogs
9. reportonbusiness.com: Farmers battered by price distortions
10. Bloomberg.com: U.K. & Ireland
11. CFTC imposes penalties against Alaron Trading | Markets | Reuters
12. AgWeb Blogs
13. Alaron Trading agrees to settlement with CFTC -- chicagotribune.com
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