Carl German, Extension Crops Marketing Specialist; clgerman@udel.edu
Index Funds Surge Commodity Markets Higher
Just about the time that the commodity markets were beginning to seem ‘tired’, perhaps reaching an exhaustion gap, several analysts began to suggest that the markets had run their course for the time being. Maybe we were beginning to see the grains and oilseeds depart from the influence of the energy markets. The problem with that mode of thinking is that in reality nothing has changed. The Index Funds are still investing huge sums of money into the commodity futures markets, invariably causing prices to bid much higher than the fundamentals (supply and demand) would dictate. In fact, due to swaps and the way that non-commercial traders can get classified as commercials there actually may be no end in sight to the seemingly ever increasing commodity prices. Index Funds invest a percentage of their investment funds in 25 commodities. Assets allocated to commodity index trading strategies have risen from $13 billion at the end of 2003 to $260 billion as of March 2008, and the prices of the 25 commodities that compose these indices have risen by an average of 183% in those five years.
This information is important for several reasons: first, something has to be done in order to restore the integrity of the commodity futures markets for commercial use (market participants with an interest in the physical commodity). Second, corn for ethanol and exports is currently getting a bad rap. The reality is that the commodity markets would be functioning just fine at the current time if the Index Funds had to abide by the same rules for trading commodities as all other participants. There is a crucial distinction between Traditional Speculators and Index Speculators: Traditional Speculators provide liquidity by both buying and selling futures. Index Speculators buy futures and then roll their positions by buying calendar spreads. They never sell. Therefore, they consume liquidity and provide zero benefit to the futures markets. Speculators have been and always will be important to the viability and function of the commodity futures markets. However, it is the job of the Commodity Futures Trading Commission to regulate the commodity futures market.
When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets. For example, the CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. When index speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits. CFTC recently held a public forum to address some of the issues that the commodity futures markets are facing and their impact on the consumer’s wallet. It is time for the CFTC to act, even if it takes an act of Congress. Farmers are beginning to report the realization that a $6.00 corn price may not be high enough to produce corn in the United States next year.
Market Strategy
Dec ’08 corn futures closed at $6.33 per bushel in yesterday’s trading within 22 cents per bushel of the life of contract high; Nov ’08 soybean futures closed at $13.55 per bushel within $1.00 per bushel of its life of contract high; July ’08 soft red wheat futures closed at $7.78 per bushel, almost $5.00 per bushel less than the life of contract high. Jul ’08 crude oil closed at $133.17 per barrel, a new high. The June ’08 U.S. Dollar Index closed at 72.08, within about ½ point of the life of contract low. For the week ending May 18th U.S. corn planting progress was reported at 73% complete, compared to 51% the week before and the 5-year average of 88%. The percent emerged was reported at 26%, as compared to 11% the week before and the 5-year average of 56%. It is becoming apparent that attaining trend line yields is less and less likely. There is no room for margin of error.
Excerpts taken from Michael W. Masters, Managing Member/Portfolio Manager, Masters Capital Management, LLC – testimony given before the Committee on Homeland Security and Governmental Affairs, United States Senate, May 20, 2008.
For technical assistance on making grain marketing decisions contact Carl L. German, Extension Crops Marketing Specialist.