The futures market offers advantages to both buyers and sellers of commodities, but what about speculators? Are they a friend or foe?
Futures are “a leveraged instrument” with the deposit typically only five to 10 per cent of its value, said crop analyst Neil Blue.
“That leverage is of great convenience to buyers and sellers who use the futures market to set a price for a physical product either produced for sale or purchased for some use,” said Blue.
But speculators use it to try to profit from market price moves and neither produce nor use the physical product, he said.
Some speculative trading in the futures and options market is a good thing in that their trading activity adds trading volume, which helps hedgers to more easily enter and exit the market.
“However, over the last 25 years, there has been more speculative money involved in the futures market,” said Blue. “It has been estimated that more than one trillion dollars is involved in the commodity futures and options trade.”
Speculative money flow can lead to higher or lower prices than what would happen without their influence. Speculative funds tend to follow market trends and their activity may, at least in the short term, seem to ignore supply-and-demand fundamentals, noted Blue, adding there are limits on how many contracts that one entity can hold in a futures market. After the financial collapse in 2008, there was an investigation into speculative activity and it was determined then that speculators did not have unacceptable market control.
“Speculative funds move money in response to market signals,” said Blue. “The majority of speculative money had been short — that is, net sell positions — with the soybean and corn markets since the beginning of the trade dispute between the U.S. and China back in mid-2018.
“A related factor is the value of the U.S. dollar, which had fallen since mid-March 2020 on the effects of the COVID-19 pandemic. A lower U.S. dollar tends to be supportive to U.S. commodity prices.
“Then, as the corn and soybean markets began to rally in mid-August on dryness and storm damage in Iowa crops as well as strong export activity, the spec funds began to offset their short positions by buying futures. As buying continued, funds accumulated a net long, or buy, position.”
Each week in the U.S., the Commodity Futures Trading Commission gathers and releases information on what groups hold positions in each commodity futures market.
“The October 6, 2020 report showed that managed money funds were net buyers of 28,000 corn contracts over the previous week,” said Blue. “That made them net long over 134,000 contracts compared to a 320,000 net short corn position in mid-July.
“Even more significant — funds had increased their net long position in soybeans to 238,000 contracts, comprising 19 per cent of total outstanding soybean contracts and approaching the record-high spec fund position of 254,000 soybean contracts.”
There are at least two implications to be drawn from this example, said Blue.
High speculative fund open interest implies that the funds may defend their position with continued buying of the soybean futures. However, should the funds decide for some reason to take profits on their buy positions, they could sell en masse, forcing the futures market quickly lower.
So what does this means to an Alberta producer?
“Our crop prices have been supported by U.S. market activity despite the harvest here of what is expected to be near-average yields of above-average quality,” said Blue. “For producers concerned with missing out on still higher prices, depending on cash flow needs, it seems prudent to sell some crop into current price strength. Then, use a put option or similar commercial pricing strategy to retain marketing flexibility and yet leave price upside open.”