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Divorce between futures and cash alarms hedgers

The market’s return to earth from a volatile February and March when futures all but divorced from cash prices is not a sign that all has returned to normal, said Anthony Tancredi, president of Allenberg Cotton Co., Memphis, speaking at the Ag Market Network’s April 4 conference call.

In fact, another massive round of turbulence could happen at any time.

“There is nothing that has changed in our marketplace to prevent this from happening again,” Tancredi said. “There are funds wanting to invest in cotton and their money is a big influence in the cotton market. It will be very difficult for our industry to survive if we have to end up having to trade money instead of cotton.

“In my 23 years in cotton, I have never seen such a divorce between the cash and futures like we just saw. It cannot be allowed to continue. I really don’t have a job if I don’t have a hedge market. I can’t take a position if I can’t trust that my hedge is going to be somewhat in relationship to the underlying cash.

“What that means is that I can’t bid a producer for a deferred bale of cotton if I can’t hedge it to guard the risk.”

Tancredi says the volatility “has completely stopped my looking to the deferred time period for an opportunity because I simply can’t expose our company to massive margin on an ongoing basis. My fear is that my job will become spot only.

“I can’t give a contract out in the deferred, or I have to put such a huge basis decrease in the bid to offset my expected increase in risk that no producer should want to take it. So the market comes to a complete standstill, or we all go out and take on more risk, and see who is the last man standing.”

Tancredi urged anyone who has been impacted by the “debacle in futures in cotton to tell their story to the Commodity Futures Trading Commission on April 22, during a forum on the issue at at the agency’s Washington, D.C., headquarters.

“I don’t think it’s a good idea to put down one piece of paper with a roll of signatures. I think you dump the mailbag on the desk.”

During the conference call, a listener commented that the level of risk that hedgers are facing is not unfamiliar among producers. “That’s our risk level all the time. You can risk the whole thing and lose it all, just like that. And we’re not very far from 40-cent cotton by the time you figure in the value of the dollar.”

On the CFTC meeting, the listener said, “We need to be very careful what we ask for. At the very least we need to think more about it. We do need to let them know we have a problem, and that it’s not working.”

Tancredi responded that he “didn’t want to remove volatility from the marketplace. If cotton wants to go to $1.70, let it go. But if the underlying cash sits at 70 cents, it doesn’t work. The marketplace needs to represent the commodity first and the money flow second. I don’t think I have the answers on how to do that, but we do need to send a message that we as an industry, top to bottom, can’t survive without that.

“Alarmist as it may sound, if we don’t fix this, next year, there will be even fewer hedgers. The funds aren’t going to enjoy this analogy. It’s like a cancer. By the time it kills all the industry, it ends up killing itself and the funds go away because there’s no more cotton market. We as industry players can’t allow this to happen.”

Tancredi says the industry has to be careful to not overcorrect the problem. “We have to have the speculator in there. But we’ve made minimal changes in rules and regulations over massive changes in the underlying structure of the market. We need to readdress participation levels and what people have to do to get in, so we can level the playing field a bit, and not give the spec funds a tremendous advantage simply by the size of their money.”

Tancredi suggested that fund activity be completely reported, “including the swap market. (A swap is a privately negotiated transaction to manage risk.) The hedger’s side of the swaps are reported and the funds’ sides aren’t, so we don’t know what their positions are. We also have a lot of investment when we go in and hedge. We buy the underlying bale, we put up the initial margin money and we keep maintenance margin money in there.

“Maybe it’s time to raise the margins on the specs to make it more difficult for them to play. We don’t want to take them out, just lower their size a little bit so we don’t feel like they can hook our nose and pull us around whenever they feel like it.”

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