Market Controversies

Futures markets Speculation Captive supplies

Futures Market Controversies

Long standing debate Speculative activity Occasional proof of manipulation Possible to trade more than is produced Close relationship between cash and futures

Range of opinions

Organized gambling Only perfectly competitive market in the

country Highly regulated

Important Function of Futures

Price discovery Risk transfer Forward pricing

Speculators

Speculators, Pro– Add liquidity to market– Assume price risk in hope of making a profit

Speculators

Speculators, Con– May mis-price commodity because they are

not farmers– Herd mentality– Large volume “Funds”

Speculators on Average Lose

Zero-sum game– Gains = losses– Brokers are always paid

Beware of “sure-fire” systems– Difficult to beat the market– Why share valuable information

Futures to Cash Relationship

Both are jointly determined by the same market forces

Futures are an anticipatory market and may change prior to the cash market giving the appearance that futures lead cash

Futures to Cash Relationship

Futures incorporate information Price discovery role Large volume, instantaneous information

interpretation may cause over reaction and exaggerate price fluctuations

Does Hedging Work?

What are the objectives???– Risk management: Don’t sink the ship– Price enhancement: Don’t miss the boat

It is a marketing tool to be used selectively to achieve specific objectives

Potential Manipulation

Illegal and highly regulated– Commodity Futures Trading Commission

(CFTC)– Limits on number of contracts held– Price limit movements

Difficult to accomplish– Hunt brothers

Forward Contract Controversies

Hedge to Arrive Captive supplies

– Market power– See Captive Supply presentation

Long term contracts– Market power– Price discovery– Encourages expansion

Hedge to Arrive (HTA)

1995-96 corn market Promoted as a way to capture “highest prices

in years” July - Dec spread was “too wide” and should

narrow. Sell multiple crops in one year

Spread “too wide”

Sell the July now then if: July goes down

– Dec should go down less (narrow)– Buy back July and sell Dec

July goes up– Dec should go up more (narrow)– Buy back July and sell Dec

Gain from narrowing spread

“Hedge” in July contract

Elevators offered HTA contracts– Elevator took futures position– Farmer was to deliver bushels

Spread did not narrow July futures increased Dec didn’t No crop in July - can’t deliver

HTA

Elevator (often coop) had margin calls– No grain to make a hedge

Farmers couldn’t or wouldn’t deliver grain– Some had 3 crops sold well below the

market

Lessons from HTA

History is not a perfect predictor of the future

Understand contracts– Put everything in writing– Read all the writing

Properly used HTA can be a good marketing tool