by MrBill » Fri 05 May 2006, 11:09:54
$this->bbcode_second_pass_quote('Pops', 'M')r. Bill you almost have me convinced (and I know this is your sole purpose in life
) that markets and speculators in particular are a good thing or at worst have no effect on prices but let me pose a simplistic scenario and hopefully you can fill in the gaps in my limited knowledge of how markets work.
Lets say I make corn flakes and know I’ll need 100 pounds of corn in 6 months. Along comes a big late snowstorm, which is sure to have an impact on the crop and the price.
Knowing this I decide to lock in my 100 pounds of corn now – but seeing an opportunity to make a profit so do many others and that speculative interim demand (for lack of a better term) really jumps the price.
So corn that had been $1 before the storm now costs me $2 and the price continues on up to $3.
But, low and behold the storm wasn’t as bad as thought and the price starts to drop as speculators that bought on the way up take their profits and 6 months hence the price winds up at $1.99 to the people like me who actually take delivery and knew from experience that was about where it would finish.
So I understand from some of your previous posts that since I’m the guy with the most experience in the market and the one who really sets the price in the end I don’t get hurt and it’s only the speculators taking money from each other.
I guess the question in my admittedly little mind is what was the benefit of the extra liquidity in the market; except to the company that makes the ant-acid the farmer takes because he sold his crop early at (what seemed for a time anyway) the ridiculously low price of $1.98?
(don’t be harsh now
)
If you trade wheaties, you probably spend sometime doing supply & demand analysis. You need to know beginning stocks of corn & other grains at the start of the growing season. You will need a crop estimate for the coming year. Maybe your own to compare against the USDA's official estimates. Then you will monitor the growing season for any expected deviations from your original forecast, and adjust your supply & demand analysis accordingly.
You will need good estimates of any imports coming into your area and any exports leaving. For this you have to have an idea of the basis between the local feed price and the price of futures at the CBOT or wherever your local delivery point is as well as rail, truck, water and barge freight rates between the local market and export or import markets.
You likely have an idea at what price your local feed dealer starts to substitute wheat for corn for barely for soybean meal for oats for fish meal for chicken poop in their feed formulas. And a general idea what your neighbors intend to do? Feed cattle or sell grain? Cut greenfeed or harvest grain or corn? And of course, everyone else in your industry is doing the same analysis. The feed companies, the elevator operators, the high fructose corn syrup maker, the foreign buyers of grain and your neighbors. If they are not doing this analysis then they are just taking price risk on the back of their own hunches. Tummy talk. The wind is blowing from the west today, so today is a good day to sell my corn.
Now assuming everyone is doing their homework they are all on the same level playing field and there is no inside information for anyone. Then between the producer and the end user are the speculators who add liquidity. They may be very sophicated and have done the same analysis or they may be technical traders and cannot be bothered. For them all the information is in the price, so no use to try to do supply & demand analysis.
They act as the liquidity between final buyer and final seller. What is their role and is it useful? Well, let us say, the price is rising and you're a farmer. You may want to wait before locking in your price for fear that you will sell while it goes even higher, and then at all the weddings this winter you will have to tell your neighbors that you sold at $2.50, and you do not want to hear the on the radio everyday at noon that futures went up to $3.00 after you sold.
The grain & feed dealer who is making feed for the poultry producer down the lane needs to buy corn at $2.50 and cannot risk the chance that prices spikes to $3.00 so he buys now. Someone has to step in between that seller who is waiting for $3.00 and can wait, and that buyer who needs $2.50 today. It might not be one speculator, but it might also be a chain of ten or 100 speculators. In the meantime (front month and futures month may be up to 12-months or more) they take the price from $2.35 to $3.15 and back down to $2.75 by the time the contract matures.
Technically, everyone is happy. The seller got his $3.00, and has bragging rights at all those curling bonspiels this winter. The grain & feed dealer locked in his price at $2.50, so he can sell his chicken feed for less than his competitor over in Hazard County. And the speculators are happy. They got to play. Some made money, some lost money. Those who won will keep playing until they lose it. Those who lost will be smarter for their experience and will maybe look to trade stocks or bonds next time. The money that one speculator takes of another is no business of the farmer or the feed & grain dealer. They got what they wanted. They hedged a rise or a fall in the price they received or paid.
Can those speculators make commodity prices go up and up and up regardless? No, because we started with that supply & demand analysis. If they take the futures price too high relative to the fundamentals of the market then the elevator operators will sell futures and buy physical grain in the country. And if the buyers are not willing to take delivery and pay storage, insurance and cost of interest (full carry) on their purchase then they want to sell their futures long before maturity.
And before next year's crop gets harvested, typically futures prices will drop in order to clear-out inventories in the elevator system to make room for next year's crop. If next year's crop is lying in the field, and there is no room in the elevator, then the grain company is going to drop the price it pays at the farmgate and offer export buyers incentives to buy grain now, so that they can get it out of the elevator terminal.
Then those futures buyers who are now holding physical grain will be competing with farmers to sell at a loss in the spot market. The farmers may be able to keep grain at home on the farm, but the speculators grain is in storage and costing money each month to roll.
Of course, the opposite may occur. The shorts always have to come to the longs. If someone sells futures they do not yet own, they need to buy them before maturity or buy the grain in the physical market and deliver it to the futures delivery point of the exchange. That may entail buying it in the country and then paying water, rail or truck freight to get it to the CBOT terminal or wherever.
Then their technical analysis ain't going to be of much use to them. Especially, when you buy a trainload of moist corn on rail and it is 90 degrees outside and sunny. And as the railroad is working flatout to ship priority coal for the electrics they shunt your cars onto a spur and there they sit, heating in the sun, until the corn starts to rot. Then you still need to make delivery to the CBOT, and you have a car full of rotten corn on the siding, which you may be able to sell for blending at 10 cents on the dollar. Forget compensation from the railroad. Unless you have a contract with them that specifies when and where and by what time they need to make delivery it all goes approximately to their schedule not yours.
Well, it has been a while since I traded grain, so maybe I missed something, but that is the general gyst of it. Hope it helps? I am really out of here this time. I had a corky bottle of white wine last night, and now I need to drink another to see if that was just an exception or not?
Have a nice weekend. Remember to eat your wheaties! ; - )
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
