• E-mail
• Print
• Comment
• Font Size
• Digg
• del.icio.us
• Discuss article

Farmers Face Volatile Risks in Futures Market

Posted on: Wednesday, 23 April 2008, 00:10 CDT

Fred Grieder has been farming for 30 years. That has meant 30 years of long days plowing, planting, fertilizing, and hoping that nothing happens to damage his crop.

"It can be 12 hours or 20 hours, depending," Grieder said.

But Grieder's days on his 1,500-acre, or 600-hectare, farm in Carlock, Illinois, are getting even longer. He has to keep a closer eye on the derivatives markets in Chicago, trying to hedge his risks so that he knows how much he will be paid in the future for crops he is planting. And the financial tools he uses to make such bets are getting more expensive and less reliable.

In what little free time he has, Grieder attends Illinois Farm Bureau meetings to join other frustrated farmers who are lobbying officials in Chicago and Washington to fix a system that was designed half a century ago to reduce uncertainty for food producers but is now increasing it.

Grieder, 49, is shy about complaining amid so much prosperity. Prices for his crops are soaring on the updraft of growing worldwide demand, and a weak dollar is making those crops more competitive in global markets.

But crop prices are not just much higher, they also are much more volatile. For example, a widely used measure of volatility showed that traders in March expected wheat prices to swing up or down by more than 72 percent in the coming year, three times the average volatility for that month and the highest level since at least 1980. The price swing expected in March for soybeans was three times its monthly average, and the expected volatility in corn prices was twice its monthly average.

Those wild swings in expected prices are damaging the mechanisms - like futures contracts and options - that in the past have cushioned the jolts of farming, turning already busy farmers into reluctant day traders and part-time lobbyists.

The U.S. farming industry's frustration was expected to result in an overflow crowd at a public forum Tuesday at the Commodity Futures Trading Commission in Washington. Interest was so high that the commission, for the first time ever, was providing a Webcast of the forum, which it said was being held to gather information about whether crucial markets for hedging the price of crops "are properly performing their risk management and price discovery roles."

The additional costs that stem from volatility in grain prices - higher crop insurance premiums, for example - are not just a problem for farmers. "Eventually, those costs are going to come out of the pockets of the American consumer," said William Jackson, general manager of AGRIServices, a grain-elevator complex on the Missouri River.

Prices of broad commodity indexes have climbed as much as 40 percent in the last year and grain prices have gained even more - about 65 percent for corn, 91 percent for soybeans and more than 100 percent for some types of wheat. This price boom has attracted a torrent of investment from Wall Street, estimated to be as much as $300 billion.

Whether new investors are causing the market's problems or keeping them from getting worse is in dispute. But there is no question that the grain markets are seeing volatility running well above the average over the last quarter-century.

Grieder's crop insurance premiums rise with the volatility. So does the cost of trading in options, which is the financial tool he has used to hedge against falling prices. Some grain elevators are coping with the volatility and hedging problems by refusing to buy crops in advance, foreclosing the most common way farmers lock in prices.

"The system is really beginning to break down," Grieder said. "When you see elevators start pulling their bids for your crop, that tells me we've got a real problem."

Until recently, that system had worked well for generations. Since 1959, grain producers have been able to hedge the price of their wheat, corn and soybean crops on the Chicago Board of Trade through the use of futures contracts, which are agreements to buy or sell a specific amount of a commodity for a fixed price on some future date.

More recently, the exchange has offered another tool: options on those futures contracts, which allow option holders to carry out the futures trade, but do not require that they do so. Trading in options is not as effective a hedge, farmers say, but it does not require them to put up as much cash as is required to trade futures.

These tools have long provided a way to lock in the price of a crop when it is planted, eliminating the risk that prices will drop before it is harvested. With these hedging tools, grain elevators could afford to buy crops from farmers in advance, sometimes a year or more before the harvest.

But that was yesterday. It simply is not working that way today.

Futures, for example, are less reliable. They work as a hedge only if they fall due at a price that roughly matches prices in the cash market, where the grain is actually sold. Increasingly - for disputed reasons - grain futures are expiring at prices well above the cash-market price.

When that happens, farmers or elevator owners wind up owing more on their futures hedge than the crops are worth in the cash market. Such anomalies create uncertainty about which price accurately reflects supply and demand - a critical issue, since futures prices set on the Chicago Board of Trade are the benchmark for grain prices around the world.

"I can't honestly sit here and tell you who is determining the price of grain," said Christopher Hausman, a farmer in Pesotum, Illinois. "I've lost confidence in the Chicago Board of Trade."

David Lehman, director of commodity research and product development for the board's owner, CME Group, said: "We know that the current global environment is creating challenges for many of the traditional users of our markets, and we are very concerned. But there are a lot of things that are changing and there is no silver bullet, in terms of a solution."

Many farmers and people in related businesses blame the tidal wave of investment pouring in from hedge funds, pension funds and index funds for the faulty futures contracts and rising volatility. But those institutional investors' money actually adds liquidity to the market, which in theory should reduce price volatility, Lehman noted.

In any case, at current levels of volatility, options trading becomes riskier, and therefore more expensive - too expensive for many farmers like Grieder, who now has to hedge with the recently less reliable futures contracts.

That exposes him to the risk of having to put up more cash - to maintain his price protection - whenever a weather threat, shipping disruption or a fresh dose of money from Wall Street suddenly pushes up grain prices.

"If you've got 50,000 bushels hedged and the market moves up 20 cents, that would be a $10,000 day," he said. "If you only had $10,000 in your margin account, you'd have to sit down and write a check. You can see $10,000 disappear overnight."

On an unusual day, he said, he might get four phone calls a day from his broker seeking additional margin. "But usually, the margin calls come in the mail, in a little blue envelope," he said. "You don't have to open it to know what it is."

Source: International Herald Tribune

More News in this Category