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Corn+Soybean Digest

Volatility Rules

Because of mass increases in fund-controlled open interest in corn and soybean futures contracts, markets are swinging wider and wider.

Volatility rules. But that may not be bad for growers.

Several market analysts and agricultural economists recommend that growers take advantage of market spikes that may not have been there a few years ago. They say lock in those high prices using futures, options or various types of forward contracts, then be prepared to protect against steep drops that are also more regular in fund-driven markets.

“The highs will be higher and the lows lower,” says Richard Brock, market economist and analyst, Brock Associates, Milwaukee, WI. “The farmer needs to sell into the sharp rallies when they occur.”

This gives producers a chance to price their crops at attractive levels, adds Darrel Good, grain marketing economist at the University of Illinois.

“Forward pricing before harvest or other planned cash market sales may become more necessary to capitalize on some of the best pricing opportunities,” explains Darrell Mark, University of Nebraska Extension economist.

And University of Missouri agricultural economist Joe Parcell points out that while fund traders usually don't take long-term positions, they often “play short-term market movements. There is more liquidity to the marketplace. Therefore, good fills and exits are more likely for hedgers. This is a positive.”

Energy futures contracts have seen the biggest increase in fund trading the past few years. Some say the $70-plus oil prices seen this year are fueled partially by huge fund activity.

But agricultural commodities are also good investment targets for these entities. It's estimated that funds make up 30% or more of the some $200 billion in commodity contracts. If funds jump from energy, more will likely land in the ag sector, says Al Kluis, president of Northland Commodities, Minneapolis, MN.

Again, this can be a plus for the farmer. “They should be disciplined and sell into it in 10% increments,” says Kluis, noting growers could “cuss funds all the way to the bank.”

Chicago Board of Trade (CBOT) statistics show the dramatic increase in open interest (OI) volume for corn and soybean futures contracts since 2000.

On Aug. 31 of 2006, volume for all 5,000-bu. corn contracts surpassed 1.3 million, with about 704,000 of this in the December '06 contract. That's roughly double the volume in the December '00 contract.

For soybeans, total OI was about 394,000 on Aug. 30, with 250,000 in the November '06 contract. That compared to about 133,000 in 2000, with most of those for the November contract.

For the end of August, OI for December corn was 357,192 in '01, 485,670 in '02, 351,875 in '03, 529,003 in '04 and 711,196 in '05. So the December corn OI jump from '05 to this year was some 600,000 contracts.

November soybean futures saw a similar pattern from '00 to now. At the end of August, OI was 133,380 in '00, 158,598 in '01, 195,411 in '02, 213,263 in '03, 174,195 in '04 and 245,479 in '05 — 100,000 less than Aug. 30, 2006.

The influx of ethanol into corn markets has undoubtedly caused price increases this year. But the volatility was likely caused by funds.

“The funds are causing short-term price volatility based on technical information instead of fundamental information,” says Parcell. “This makes ‘traditional’ hedging strategies more complicated because one needs to pick the peaks and valleys of volatility in order to exit or enter at the price level they desire. The fund involvement makes it easier to get in and out of the market but one has to watch (technicals) more closely to know exactly when to pull the trigger or else wait out the next wave of volatility.”

Mark notes that funds likely exit a futures contract near its expiration, creating selling pressure that can cause prices to drop. “The result is lower prices in the spot market for producers,” says Mark. “Thus, it may be increasingly important for producers to quickly recognize pricing opportunities and take them early.”

Brock, in his February '06 The Corn And Soybean Digest column, points out that “there is a big difference between a commodity fund and an index fund, and the impact each type has on a market.

“Index funds have only been around for a few years and were created for the benefit of investors who only want to be long (own) commodities,” he says. “The viewpoint is that investing in a commodity index fund is an inflation hedge and also an opportunity to take advantage of China's insatiable appetite for world commodities. They are always long — never short.

“Standard commodity funds, on the other hand, can be long, short or spread. There is little question that the influence of commodity funds on commodity prices in the short term has increased substantially,” Brock says.

From 1990 to 2000, the value of commodity funds had risen to more than $30 billion, “and the number will soon be near $140 billion (or higher),” says Brock, meaning there can be wider volatility.

The impact of fund trading on seasonal prices is arguable. “I don't see any evidence to date that seasonal patterns have been altered,” says Good. “Prices generally respond to overall fundamentals, but with some distortions in terms of volatility and price level.

“The one case where the ‘new traders’ may have created some wrong signals was in the late winter-early spring of '06. Soybean prices were too high relative to corn prices and gave producers the wrong signal about what to plant in '06,” says Good.

“What I have observed is that this increased short-term volatility is playing heck with basis levels,” Parcell says. “Typically, basis is considered to be fairly predictable, based on historical basis levels for a given time of year. What producers may be finding is that current basis level is nowhere near historical basis levels.

“Generally when this happens we think of a short crop or bumper crop in the local area impacting basis. However, the basis level change looks to be credited to fund action in the market. Thus, producers may find it difficult to determine what their actual local price will be,” Parcell says.

As far as actual trading patterns are concerned, Good says growers should use similar guidelines as in the past, but still realize that market swings can be wider.

“The net effect of the new traders appears to have been to push prices above fundamental value at times, giving producers a chance to price their crops at attractive levels.”

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