Dec 30, 2011
New year, new challenge

Coming into a new year is always filled with optimism for a better year for many reasons. When it comes to Ag commodities, it would be hard to think of prices getting any higher. I was visiting with Jim Robb at the Livestock Marketing Information Center last week and he told me his calculations for cattle feeding breakeven for March were at $137 per cwt., a full $10 higher than his current breakeven mark of $127 per cwt.

How on earth is the market going to make that happen, especially now that there seems to be growing distrust for the Chicago Mercantile Exchange (CME), and their role in the MF Global bankruptcy. MF Global misplaced $1.2 billion from what were supposedly secure commodity trading accounts CME was regulating. Bankers and traders are a bit angry over the lack of oversight from CME and a little less trusting of the market that had a club-like, insider feel many years ago; they are concerned about the confidence in this market and the security of their margin accounts, along with liquidity.

CME, trying to downplay their role in the debacle, said that this was a failure of a firm, a firm that broke the law and that CME has met its obligations. CME also said, before Congress, that they were the victim because they were deliberately misled by MF executives, days before the collapse, demanding proof that customer funds were secure. This in itself makes it look like CME may have known something.

I know many of you have those accounts. Imagine waking up one morning and finding out a trusted financial partner cleared your account to buy Greek bonds, which MF did. Greek 10-year bonds were yielding 29 percent last week. Needless to say, those bonds are a high risk deal. If you’re a cattle feeder and had an account at MF Global, you would have a hard time hedging your cattle if your margin funds are gone.

The MF Global debacle has hurt trade volume in futures trading which, for most producers, is risk management. The open interest on futures contracts, the sum of both long and short positions, has dropped nearly 10 percent since MF went down. We know, futures markets are an important part of price discovery. MF Global was the most active trader in metals and energy exchanges and the second most active at CME trading Ag commodities. A lot of people had big money sitting in margin accounts at MF Global.

Traders are saying that this is CME’s problem because they are the regulator for MF Global and they were supposed to be first line of defense for the trading firm’s customers. The futures trading industry has fought to be self-regulated for years, claiming that no futures trading customer has lost a dime because of trading firm failure. CME has decided to pony up some $600 million to make things right.

Many market watchers are saying that we’re sure to see some regulation come to CME. Commodity trading accounts are not insured like bank accounts and securities accounts, and there have been proposals made to set up an insurance fund for those margin accounts. It seems almost certain that CME will enter a period of regulation and additional oversight.

If commodity trading volume declines, it will reduce liquidity for some commodities, like a feeder cattle contract. The trading volume for producer/ merchant/processor/users was down 623,000 contracts based on the sum of both long and short positions. The small speculators were down 700,000 contracts, or 14 percent, mostly closing out spread trades. And the “Managed Money,” the big hedge funds, were only down 11,000 contracts, or 2.4 percent. “The data speaks to the profile of MF Global’s account holders,” said Ralph Preston, a market analyst at Heritage West Financial.

Agni-Pulse, a commodity trading publication, said this MF Global debacle is really a big deal, and probably more important to farmers than the Farm Bill. If the regional banks (not too big to fail) and Farm Credit system lose confidence in the marketing system and view those hedge accounts as having risk from unauthorized use, then the whole marketing chain is in trouble; grain elevators and cattle feeders need margin money to manage risk for stored grain and cattle inventory.

It will be interesting to see how CME and the futures and cash markets behave in the months ahead. Cattle feeders and packers have big pricing challenges ahead. — PETE CROW