Price Discovery and Feeding The Bull, My Hour on the CME Trading Floor

     You gotta feed the bull every day!  That was the retort of one of the traders on the floor of the CME today as the CME Corporate Director of Communications, Chris Grams, took me for a trading floor tour.  Chris had just introduced me to one of the more famous traders who appears on CNBC from time to time, and that’s the retort he gave me.  Little did I know corn was down about 20 cents at the time!

It was a pretty big day for me.  I’ve always wanted to tour the trading floor of the CME and I got my wish this time during a short stay in Chicago.  It is what it is, a cauldron of price discovery and a haven for those mitigating price risks.  Director of Communications, Chris Grams and I were engaged in some great conversations about how things worked, the new risk management tools the CME was offering, new business on the horizon and a whole host of other questions.  I hardly understand the nuances of the exchange, but for those of you with an interest in price discovery, a trip to Chicago and a visit to the CME are well worth it.

For those of you who have read this column over the last 25 years you know, I’m big on “price discovery”.  This coming week, I’m speaking at five different locations across southern Ontario for Farm Credit Canada.  I’ll be laying out the grains market as I see it with a big discussion about Canadian market conditions.  However, at the end of the day, I’m sure I’ll be asked, “what’s the price of corn going to do?”  The answer of course, is “I don’t know.”  However, I’ve often thought the better question is do Canadian farmers have a system of “price discovery” that works?

In the past, I’ve questioned that openly, but as the years have gone on, I’ve softened my stand.  For instance, the price of corn in Ontario is created by the supply and demand for corn.  In Ontario, that’s directly related to the US replacement price for corn.  For soybeans, its related to what end users pay for soybeans in the province. Ditto for wheat.  Add a basis to the nearest futures contract value, and you almost have me satisfied that a true price discovery mechanism is at hand.

A visit to the trading floor has a way of reinforcing that.  Chris and I talked at length about the different contracts offered by the CME.  All of them were vehicles for end users and producers to mitigate price risk and all the products had very good intentions.  There may be a “gulf of understanding” between what those products are and how they can be used at the farm level, but they are there nevertheless.  Its up to guys like me to find out how these products can mitigate price risk and tell the world.

Interestingly enough, the busiest trading pits at the CME were the “options pits”.  For instance the corn and soybean pit were very quiet.  A reason for that is most contracts (85-90%) are traded electronically, so there is not much reason for traders to be standing around yelling at each other.  The “options” pits were much more crowded, with a much lower percentage traded electronically.  I asked why and Chris explained to me that some of these options trades are much more complex, with traders working with end users and often it needs that added human touch.  Interesting stuff, it was a good answer as far as I was concerned.

That became clearer to me after the close of trading when I met one of my Twitter friends, Rob Levy, a wheat and corn futures and options trader.  I’ve followed Rob on Twitter for quite some time, while in Chicago we got together for a face to face.  It was fascinating talking to Rob, because he works constantly trading options.  I told him it gets confusing.  He told me he understood, because it’s very complicated.  I was getting dizzy just listening, but it was all great stuff.  I knew somewhere in the equation, an option was being traded somewhere to mitigate some of that corn and wheat price risk.  It’s all part of the price discovery paradigm.

So then Rob asked me a real question.  He said, “What do you think of Brian Mulroney?”  I stared back hardly believing what I heard.  I told him about the “cold hard cash” stored in a safe at home, outside the parlance of Revenue Canada.  Rob shot back that he had gone to school with his son.  We both laughed.

So what does it all mean?  Well, let’s just say this.  “Chicago” in Canadian agricultural terms sometimes comes across as a swear word.  There is surely a long history to that.  Add foreign exchange and cross border delivery to the futures prices of our Canadian agricultural commodities and you get a large part of our price discovery process.  So it doesn’t start and end in “Chicago”.  Needless to say, that’s a large part of it.  Key is to understand what those trading pits mean there.  They are very real, and very efficient.  Studying and visiting that process can only do Canadian farmers a world of good.