When most people hear “derivative” they think about the iffy financial instruments blamed for the near collapse of the U.S. financial system in 2008.
Most also hear “speculators” and think of traders out to make short-term profits at the risk of the long-term good.
There are, however, also derivatives in the agricultural trading world. So, did they play a role in the market collapse? And is investment buying by index funds responsible for artificial run-ups in prices of agricultural commodities? Does the volatility they bring to the commodities market hurt the buyers who are in the market to hedge their risk in the buying and selling of real, physical bushels of grain?
Those were the questions journalists posed to experts during a panel discussion in Washington, D.C. last month. Panelists included David Lehman, managing director of the commodity research and product development center with CME Group; Michael Masters, founder and chairman of the board of Better Markets Inc., and Todd Kemp, director of marketing and treasurer of the National Feed and Grain Association.
Predictably, the panelists had somewhat differing views of the danger (or benefit) that derivatives and hedge funds play in the markets.
Agricultural futures trading in live cattle, lean hogs, feeder cattle, corn, wheat, soybeans, soybean meal, soybean oil, rice and oats have been around since 1870. Similar trading in milk, cheese, butter, non-fat dry milk and whey are much newer: only about 10 years old, Lehman says.
Lehman says that futures trading on the Chicago Board of Trade and the Kansas City Board of Trade of set the benchmark for world market prices of corn, soybeans, wheat, soybean meal, soybean oil, oats and rice.
Livestock prices, he says, are much harder to benchmark because of the wide variation of quality and grade, which makes price discovery difficult.
Lehman says that speculators in the market are actually a good thing because they provide the liquidity that hedgers, those who deal in the physical delivery of grain and livestock, need.
He agreed that today’s volatile prices have hit records, but pointed out that if they were adjusted for inflation from the previous highs in the1970s, which also came at a time of instability in the Middle East and a huge run-up in oil prices, they would be far, far higher.
Ag derivatives are a small part of the market, only about 10 percent of the futures and options contract size, he says, while oil, energy and credit derivatives are six times the size of the Chicago Mercantile market.
Lehman argued that balance is good, that the net long positions of non-commercial and index traders balance the short positions of hedgers and that is a good thing.
Masters, however, pointed a much different picture. He says that the balance of long and short positions is simply a reflection of money moving into the market and that a more realistic picture is the balance between hedgers and speculators. In the 1990s, before deregulation, hedgers were 70% of traders and speculators were 30%. Today that is reversed, he says, with 70% being speculators and 30% hedgers.
“Index funds don’t buy on supply and demand but as an asset class,” he says. “Yes, there is a balance. When new money comes into market, it will always find the other side. The real question is at what price.”
His organization advocates limits of 30% of spot interest. “There are plenty of academic studies to show that speculation impacts prices and that index funds in the commodities markets are disruptive,” he says.
Kemp says speculator is not the dirty word some people think it is. “We need speculators,” he adds.
Lehman agreed that agriculture got swept into the net when Congress moved to tighten regulations after the 2008 market collapse, which was fueled largely by credit default swaps traded over the counter.
“There has never been a default in the history of the physical exchange markets,” he says. “The problem was in the OTC trades.” --Griekspoor writes for Farm Progress sister publication Kansas Farmer.