Looking At Volatility: Do Our Grain Markets Give It New Meaning?

Volatility.  It’s a word I’ve used rather loosely over the last 20 years of writing this column.  If you are in the agricultural business it is something you get very used to.

A few years ago, there was a teachers strike taking place over a period of extended weeks.  I didn’t pay much attention to it.  In Ontario we are somewhat used to these things.  So after several weeks I asked a parent what the issues were.  She told me $1500/year in salary and 4 minutes of prep time a week.  I was aghast.  I looked back at her and said, “they wouldn’t make very good farmers would they!”

The point wasn’t one against the teachers.  It was more in jest because typically farmers can lose that much money in 5 minutes on the commodity market.  Add the ruse of bad weather into the equation, like this year in Ontario and farm income can drop precipitously.  If you grow up farming, you think this is normal.  Get out into the real non-farm world and you find out this type of income volatility is legislated against.  Go figure.

We now are in one of those times when the word “volatility” has come home to roost.  Musings from me and others over the last few months have implied price volatility ahead.  So when you look at commodity markets over last six weeks maybe we’ve hit pay dirt.  Prices are higher, a lot higher.  The bulls are eating hay.  Many analysts are saying we’re just getting started.

On September 12th December corn futures were $2.37/bushel.  As I write this December futures are at $3.27/bushel challenging resistance levels, which only a few weeks ago were thought to be in some fairy tale.  That’s a 90-cent gain in about six weeks.  Regardless of how many of us told you it might be coming, nobody predicted price movement upward fury.  So now that we’re here everybody wants to know what is going to happen next.

I certainly get some clues from the six factor market analysis put together by DTN’s Senior Analyst Darin Newsom.  Quoting from DTN on Air, he says understanding what kind of market exists is necessary to decide what to do in it. He says it’s possible to understand what kind of market exists and why the funds do what they do by reviewing six basic market factors: trend, noncommercial position (speculative investment), commercial positions, seasonality, historic price probability, and implied volatility.  To read the synopsis, go to DTN News on October 26th.

It an interesting read and very relative for the times we are in.  However, what I take back from it is we can’t judge the markets in a way, which we traditionally have.  International money and hedge funds looking for a home act differently in commodity markets versus what we are used to.  They add liquidity to the market, which makes for higher highs and deeper lows.  Is it is a good thing?  Or is it just the way it is?

You’ve heard me say it before.  The market is always right.  So the way it is now, with those six factors from Newsom is the reality we have to deal with.

The question is how much volatility is ahead and how will some of these non-traditional market players react to it.  Are we building a “Enron” scenario here or a more Canadian style “Bre-X” market scenario.  Or is the perceived upside in this bull market everything to do with the ethanol gold rush talked about so much in the lead up to this very wet fall?

I think we all know what the Enron scandal was all about.  For my American readers “Bre-X” was a great Canadian-Indonesian gold rush fraud.  The only guy who knew the truth about the gold exited a helicopter 250 metres over the jungle.  There was no gold.  Canadian investors had flushed money into Bre-X in the run up, only to see it vanish over night.  Is the ethanol gold rush something like Bre-X or Enron, or is there real sizzle in this steak.

To be fair it’s about neither.  Ethanol is about fuel made by corn or some other feedstock.  However, I bring up Enron and Bre-X as symbols of what can go wrong in a “gold rush” mentality.  With all the speculative funds and non-farm money within our commodity markets adding liquidity it might make you wonder if all that volatility is warranted.  If grain prices really take off, reaching levels we’ve never dreamed of, it’ll surely open the gates to new interlopers in the commodity market.

How this would play out I don’t know.  Keep in mind six weeks ago this upward price volatility in grains was only a theory.  Now, the whole psychology of the market has changed.  For a guy who’s been writing about bears for months now, seeing those bulls eat some hay isn’t so bad.