When There Is Smoke Is There Fire? A Canadian Ponders Price Manipulation and Price Discovery

Most of you know I’m a big basketball fan.  I played the game for years until I was literally forced to give it up.  I know in Canada we’re supposed to live, breath and love hockey.  I do watch the NHL finals and if Toronto ever gets a hockey team I might tune in.  However, I never miss a Piston game.  With March Madness before us its time for me to call my former editor Kathy Myers at DTN.  I’ve never met anybody who shares such a passion for college hoops.

I open with that because I was writing a piece the other day regarding our commodity markets and I thought of a day gone by at the Pontiac Silverdome near Detroit Michigan.  Your loyal scribe was at the Piston game, row 10 (that’s how long ago it was) and the two guys in front of me were betting money on every play.  It was the most bizarre thing.  Every play they’d get up, drag on a cigarette and jam cash in each other’s hand.  They were the most risk adverse guys I’d ever seen and it kind of reminded me of today’s grain markets.

With all the speculative money in the market, it’s become even more volatile.  It is this way partly because there is an 80% correlation between the net position in the grain market of the funds and price movement.  So when the herd is going one way, 80% of the time price will too.  20% of the time somebody is losing their shirt.  It’s like they are those guys back at the Silverdome betting on every play.  The thrill is in the risk taking.

I spoke about this last week at the Western Fair Farm Show and I got some questions.  For instance a Bothwell, Ontario area farmer asked me who was on the other end of those trades.  In other words, if the 80% correlation is correct, who are the suckers on the other end of the buy/sell orders?  I gave a few answers to that question, with one of them being “I don’t know.”  However, in retrospect its pretty obvious.  Many of the dark suited pin striped pirates within the funds were buying and selling to themselves.

There is nothing particularly wrong with that.  For instance the funds add liquidity in the market which farmers can take advantage of.  For instance $5 corn and $13 soybeans are testament to that.  However we all know how the run up in futures prices has decoupled the traditional cash markets for grain.  In some instances farmers still can’t contract grain, simply because there is such a disconnect between futures and cash.  Still, there is a bit of a smell to this.  Some folks might say the funds are manipulating or at the very least having too much of an undue influence on the price of grain.

If you read Chris Clayton’s excellent piece entitled “CFTC Cautious About Increasing Spec Limits,” you’ll know the US Commodity Futures Trading Commission is watching.  In Chris’s piece he quotes Walt Lukken, the acting chair of the CFTC.

“Our primary mission and mandate at the CFTC is to ensure that nobody is artificially manipulating our markets,” Lukken said. “So this is something that we watch very closely. That’s something we look at daily, in almost real-time fashion so we know who are the speculators, we know who are the hedge funds, we know who are the commodity indexes in these markets, and we are pretty confident that manipulation is not happening in these markets.” (CFTC Cautious About Increasing Spec Limits)

When there is smoke is there fire?  Does just talking about this in today’s super heated grain market imply wrongdoing?  Or is it a case where farmers are openly questioning a futures market in Chicago for their price discovery mechanism?  Or is somebody acting like those two guys betting on every play making no sense at all?

I dunno.  Clearly though the Canadian response to this has been deafening silence.  Price discovery for grains and oilseeds in Eastern Canada has always been done based on a Chicago price plus or minus basis.  However, in 2008 many American farmers are openly questioning that, but in Canada I don’t hear a thing.  The prevailing opinion seems to be we’ve never been able to do anything about it so why question it now.

On March 28th the daily limit for corn futures may increase to 30 cents/bushel, for soybeans, 70 cents a bushel.  It’s all up to the CFTC.  How this will play out once again I don’t know.  However, its pretty obvious to me this old model for price discovery for Canadian grains and oilseeds especially in Eastern Canada is flawed and outdated.  In our current environment its almost like we’re discovering Canadian farm gate prices like those guys betting on basketball plays.  There is no rhyme or reason, just follow what Chicago does.

I think there is a better way especially in light of the current disconnect between futures prices and Canadian cash markets.    That starts with Canadian farmers talking about it and actually pursuing something different.  At the end of the day a Canadian price discovery mechanism would be better for everyone.