OPINION: Beware — spec funds and short sellers can move markets

As grain producers, we tend to think of market movements being caused by things which fundamentally impact the supply of grain or the marketplace’s demand for it. However, there are actually a number of other drivers of commodity prices and this past spring has been a great example of how speculators can drive the market, and why we as farmers should be aware of these market forces and use it as a tool in optimizing our marketing decisions.

For much of this past winter, conversations about the grain markets amongst members of the agricultural community have included a certain amount of grumbling about how the spec funds, or managed money in the futures market were carrying massive short positions which were holding prices down. In trading lingo, “short” means to have sold something that needs to be bought back in, so if a fund is “short” corn futures, it means that they have sold corn futures under the expectation that values will fall, and they can buy those futures contracts back and earn a profit by purchasing them back at less than they had originally sold them for.

The story about spec funds being short is entirely true. In fact by the third week of April, in the Chicago Mercantile Exchange weekly “Commitment of Traders Report”, the spec funds were short a record 76,184 contracts of wheat futures and options. Of course, the greatest risk in being short is that prices start to go back up, so when some bad weather news like drought in Russia started to make the headlines and wheat prices began to rise, there was a great deal of managed money that needed to buy wheat futures before their situation deteriorated and the sharp move up began.

The speed at which the managed money bought in their shorts in the wheat market was astonishing. On April 23, the funds were short 76,184 contracts, which at 5,000 bushels per contract is more than 10 million tonnes, or about 1 year’s worth of the entire U.S. soft red wheat production. A week later, on May 4, the funds were short 47,806 contracts, and by end of day on May 14 the funds were even or perhaps even slightly long.

What’s really important to appreciate as farmers and grain marketers is not simply the speed and volume at which funds can buy futures, but rather how big of an impact that volume of purchasing can have on price.

On April 23, (when the funds were at their peak short on wheat), CBOT July wheat futures traded at $5.83. On May 6, they were up to $6.10. By May 10, they made $6.65, and by the day that the specs had closed out their shorts on May 14, July wheat futures had reached $6.96. In the course of buying in their short position, the fund buying pressure had propelled July wheat futures up $1.13, or 16 % higher. Any force that can move a market by 16 % in 3 weeks is really critical to understand.

One important thing to remember about futures trading is that there is an off setting party to every trade. In the same way that you can’t bet on the Maple Leafs’ game unless you can find somebody who will bet against you, you can’t sell a futures contract unless someone else wants to buy it. The truly beneficial thing about the massive wave of fund buying which we saw in late April and early May is that even with really active commercial selling of wheat, the volume of selling didn’t overwhelm buying and push prices down. Farmers were able to take advantage of the rally and make enormous volumes of cash sales and forward contracts and never run out of buyers. The appetite for purchasing created when the managed money tries to buy the equivalent of a year’s worth of soft red wheat over a 3 week period is that it sustained a $1.13 rally while an ordinary enough wheat crop continued to grow in the field.

The big rally which we experienced in Chicago wheat futures in late April and early May was not the result of harsh growing conditions reducing the yield potential of North America’s soft red wheat crop. It was spillover anxiety created by concerning weather in other wheat producing regions, which triggered a reversal in how funds approached wheat markets.

The fund participation in the market is not always as useful to farmers as the rally which we experienced last month. But there is no need to be bitter about it either. The managed money’s impact on the commodity market can have both good and bad impacts on farm business. Think of it like rain. We’ve all had experiences where an ill-timed rain made a mess of our plans, but at the same time if we had no rain at all the consequences to our crops would be catastrophic. In the same way that as farmers we monitor the weather forecasts and try to adjust our plans to utilize the weather, as marketers we need to be aware of the fund positions and adjust the timing of our plans in order to best capture the opportunities which they create.

Steve Kell is a Simcoe County crop farmer and handles grain merchandizing for Kell Grain, with elevators in Belleville and Gilford.