Beef magazine recently ran a series of articles from Private Market Advisor Nevil Speer about the inner workings of the futures markets. Beef has graciously allowed their reprinting here.
This is the third in the series, edited for length and style.
FUTURES BY ANY OTHER NAME
Futures markets seem to illicit an array of descriptions – that often depends upon one’s background and/or experience using futures markets. Charles Geist described it this way in his book entitled, Wheels of Fortune: The History of Speculation from Scandal to Respectability where he said futures were vital yet dusputed.
Within the discussion, speculators often get a bad name – especially around agricultural contracts. Geist’s most compelling illustration revolves around a popular publication during the 1880s: Seven Financial Conspiracies That Have Enslaved the American People (Sarah E.V. Emery). The over-arching theme was “…to show how the average agrarian was at the mercy of the Wall Street crowd that cared only for money, not products.”
To that end, the past several years have seen a lot of volatility at the CME. That’s especially true when considering large intra-day swings. That’s made decision-making very challenging along the way. However, these intra-day swings are due primarily to High-Frequency Trading algorithms – not speculators.
For the purpose of this discussion, set aside HFT, and take a longer view. Since late October the cattle market has experienced a solid rally. For example, the front-end contracts (December and February, respectively) surged nearly $25 in just over 90 days.
And along the way, it’s been the non-commercial (speculator) positions that have been on the long side of the market. These non-commericals were net long by about 13,000 contracts in mid-October. Since then, they’ve added nearly 83,000 contracts to their position.
Meanwhile, commercial users (hedgers) have been active, too. They’ve laid off their risk taking the opposite side of the market – adding nearly 65,000 contracts to their net short position. In other words, long speculators have systematically purchased contracts while the commercials (short hedgers) have gladly obliged on the other side.
That action is lockstep with futures’ market theory. The speculator takes a long futures position with expectation that price in the future will exceed current futures price (assuming rational decision-making).
The hedger wants to avoid risk. He/she is buying insurance from, and transferring risk to, the speculator. As such, the short hedger must be willing to sell a futures contract at some level below the expected future price of the commodity (otherwise the hedger cannot induce the speculator to assume a long position – the discount being what the hedger pays the speculator for assuming risk).
In other words, speculators have provided a great opportunity for hedgers to get some price protection in recent months. That’s right in line with futures market theory.
Many producers apparently used the run-up to obtain price protection.
CATTLE, BEEF RECAP
Cash cattle traded in Iowa last Monday at $114 per cwt on a live basis, steady to down $2 from the previous week. Late-week trade was at $110 to $113, down $1 to $3. Dressed-basis trade was at $181 to $183, down $2.
The USDA choice cutout Tuesday was up $7.74 per cwt at $226.36, while select was up $2.79 at $200.58. The choice/select spread widened to $25.78 from $20.83 with 116 loads of fabricated product sold into the spot market.
No cattle were tendered for delivery against the Aug contract Tuesday.
The CME Feeder Cattle index for the seven days ended Monday was $140.08 per cwt, down $1.02 from the previous day. This compares with Tuesday’s Aug contract settlement of $127.72, down $6.67.