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Senior Advisor

So, hedge funds got clipped?

That's the story on Agrimoney. And it brings up a point we need to remind ourselves of. The jumping around of futures prices in reaction to government reports and other 'news' doesn't necessarily reflect the nature of the physical market. In this case it might be said that it is a complete exageration of actual physical markets. Thye reason is simple. Futures congtracts are bought with leveraged money.

 

Buying contracts with leveraged money means one can buy more contracts (more fees for the CME) and just by that fact alone introduces vast amounts of volatility. A person who owns a bushel of grain may be dismayed by a 20% drop in prices through the effect of futures exchanges. The spec can be totally wiped out by the same change in price. And since the spec can buy many contracts at a fraction of the face value of a futures contract they can increase their risk by multiples compared to the farmer's bushel of grain. That means behavior triggered by the slightest hint of a big move. Of course the aim ias to make money in the same way but the magnitude of risk is commensurate w/ the amount of contracts, (unless they are offsetting contrats that limit the possible reward).

 

So, the market takes a dump in this case. Not because of any assurance of radical change in the physical factors but because of the exposed nature of many contract owners - in this case the hedge funds that were exposed with long positions. And now with electronic trading these factors of volatility and over reaction are amplified and multiplied.

 

In the above sense the futures markets increase volatility and risk in the market. And cost. Reminds me of the insurance salesman reminding you to get coverage on your house and his favorite past time happens to be lighting matches.

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15 Replies
Advisor

Re: So, hedge funds got clipped?

They can take er up and they can take er down. The real question is :What is the true value of corn today. Is is $7.40 or 6.40 or somewhere in between.?? Basis should begin to tell the story.

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Senior Advisor

Re: So, hedge funds got clipped?

The true value of a commodity is always a matter of conjecture and circumstance but, the futures market is a source of occasional and sometimes frequent distortion. It's like asking what the value of the contracts are. As long as the contracts do not realistically represent actual corn - and they don't for the most part - it is just a fear based activity based on the dangers of using leveraged money to make money. On the other hand, pointing this out just irritates those who trade paper because they need the fig leaf that their trading is a productive economic activity beyond the rather arbitrary attempt at making money while trying to avoid the abyss.

 

In the end the activity will be left to organizations trading electronically and having machines that keep an eye open to other machine's psychological tendencies. Yeah, farmers can buy options but the expense becomes prohibitive. It would be nice if deliverable contracts could be had by producers but that would put those who are only playing the paper game in a position of maybe actually having to considers the logistics and associated costs of real world materials and dealing with them - which they don't want to do.

 

In the end it appears that subsidized crop insurance is the best way out of the unrealistic paper game for producers. I fear that this type of insurance has its own major issues but futures trading has become like the larger economic paper game of financial rewards on Wall St and elsewhere. It's not for the commoners. You can't compete w/ bags of money traveling at the speed of light divorced from reality. There isn't a level playing field anymore and there never will be again unless Teddy Roosevelt rises again - highly doubtful. The connection between paper and grain is largely illusory. I maintain the futures market has no insight. But it's capable of creating turmoil faster than anything else for no better reason than reaction time. It has its effect but there's nothing to be done about it except stay out of the way and pause marketing activities while meat eating electronic dinos fight over a leaf.

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Honored Advisor

Re: So, hedge funds got clipped?

Palouser,   excellent posts...thanks.   Do you think with the wipeout  in the hedge funds that just happened, it is setting up for a historic move in the other direction?  Similar to the wheat market a few years ago?

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Senior Advisor

Re: So, hedge funds got clipped?

The parabolic rise of wheat prices in 2007-8 was all about the paper market and buyers ignoring supply trends. Physical does trump paper completely when buyers of physical realize they have to line up a supply stream of grain and the pipeline starts to stutter. Those who think the wheat explosion was a matter of a spec bubble just weren't paying attention. True, the paper market reacted strongly - and it also reacted too late to do anything about supply. But, in fact, physical prices outraced paper a good part of the time then. It would have happened even if there was no paper market at the timem - except for the possibility that market might not have been so sluggish so long.

 

The alleged losses among hedge funds isn't really too important. It's just money. And we still don't have a good idea what grain supplies will be this next year - and that's EVERYTHING. It doesn't matter what traders of any stripe think about projections, etc., in the end. It's all vaporware. I think Gulke is right that we could have good crops but, if we don't, then what? One could sell old crop today and kick themselves tomorrow as things change. I try and keep my eyes on the larger trends. It takes something to change them and that's what I look for. But mainly global demand is written in stone.

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Advisor

Re: So, hedge funds got clipped?

Well do we need the board?? Cash to cash .

 

How do we determine fair value. I've got a dab of old corn left. Will I take 6.40 ?? for it today?? NO! Will I take 7.40 for it?? maybe. Will I take 8.00 ??? Absolutely every last kernal.

 

Are there any cash sellers at today's prices. If so I may be out a luck for awhile.

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Veteran Advisor

Re: So, hedge funds got clipped?

it was the large specs (inst $$$), not hedge funds so much, who sold

.........the physicals (commercials)--the crowd who actually handle and deal with the product (Corn) are ALWAYS in control (strong hands) of these commodities--were selling BEFORE report & bought all the way down.

 

The specs will always be a lagging indicator---maybe this idea is linked to how you say futures are this, Palouser?

 

any market would react in this manner with the #'s presented......the reaction was commensurate with the data USDA published....extreme.

 

my only point is, if there's any computer analogy it's the mkt being connected to economic data published-----          

      THE market  (all grains) futures and physical alike are not only NOT separate systems reacting to different "things" --- they are SAME coin or system, simply different facets or sides.............so the mkt is inextricably programmed to react a particular way to the USDA data once it is presented.

 

...in this case the "data" was significantly (extreme) outside range of expectations, statistically speaking......based on the "new information" from USDA whether it's close to reality or not is COMPLETELY irrelevant.....all facets of mkt HAVE to adjust--------in this case, sell. 

 

as you say, at the end of the day, the fundamental economic conditions will be expressed in mkt...... IMO---as mktg year progresses, USDA has less "wiggle or fudge room" thus having to "land" back TO reality as the rubber hits the runway.............

 

 

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Senior Advisor

Re: So, hedge funds got clipped?

I'm NOT completely in disagreement w/ your explanation. There are relationships - or the futures market would become absolutely incomprehensible in short order. I will maintain that paper bought on margin will tend to over-react to ANY information, valid or not, rumor or fact, because of the risks of getting wiped out. Therefore fact isn't as important at any moment as perceptions and the behavior of the herd and the cascade effect - whether they be right or wrong. Actual physical fundamentals can be irrelevant. And that's why reports seem to prompt violent and usually temporary market swings for up to 10 days. Each time it's as real as it gets - before things go on. This is rapidly becoming the norm. If the futures had any real foresight we wouldn't even need reports as time posts.

 

And I agree that funds tend to react - for the most part - less than true specs. I do discount the idea that the USDA is much of a factor. Reality and the larger trends change little. The degree to which the figures change aren't of the same magnitude as the futures. I'm guessing that we will look back and see that the reaction to the last report didn't come very close to getting it right. If that's true then I can maintain my position the market has little to no foresight. We'll never know but, I'd guess a cash market using margins on real supplies in the information age might be more considered and efficient than the distortions introduced by electronic 'paper' on a margin. But that would reduce the number of games for true wealth.

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Honored Advisor

Re: So, hedge funds got clipped?

So.......a paper market with buyers ignoring supply trends.............Sounds somewhat familiar.

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Veteran Advisor

Re: So, hedge funds got clipped?

Equity markets?

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