commodities trading...help me understand

[jimg]

I know there are a bunch of smart folks here who can help me understand ag commodities trading and how prices are set. Im looking for the laymans version. The reason I ask is the TN Farm Bureau News featured an article titled 'Turbulent futures markets challenge farmers'. In that the author makes some really surprising stmts about who gets what from advertised prices and what forces govern ag commodities. In fact a simple overview would be helpful too.

Heres how I thought it worked. A farmer could 1) lock into a future price (before the crop was planted), 2) hold his produce and sell on the spot market or 3) grow for someone on contract and be paid a set price est. at the beginning of the contract. Each has its own pros/cons and I think I see most of the obvious ones. At any rate my hats off to anyone making money at it. Going back to 1 & 2 if the advertised price was $8.00/BU then thats what the farmer got paid (or so I thought). The article states: 'While sky-high future contract prices cause many Americans to believe farmers are bringing home the proverbial bacon, the reality is that few farmers benefit directly from from the contracts advertised by the commodity exchanges.' Really! So who does benefit directly and how does the farmer indirectly benefit? To me it implies a middle man taking some for himself. How much of the contract price does the farmer get?

Heres the 2nd stmt that left me confused: 'He also said the role of speculative and commodity-index-related trading in ag futures markets , while growing for some time, has reached historic levels and contributes to market uncertainty.' The 'he' is Bob Stallman AFBF president testifying before Congress. What is 'commodity-index-related trading'? Lately, from some of the ag shows I watch, analysts are saying there are no fundamental factors for current market prices. In other words, from their POV, prices aren't reflecting supply/demand. Do I have the right? Seems that speculation is/will causing some pretty significant problems.

 

[EarPlug]

I don't type very fast so I'll just list some links to follow on this subject

Commodity - Wikipedia, the free encyclopedia

Futures exchange - Wikipedia, the free encyclopedia

 

[jimg]

Yes, that helps some but it still really doesnt answer my specific questions...at least I didnt see any recognizable answers there.

 

[js5020]

I read somewhere the at one point there was a "need" in the market for 375 million barrels of oil,,, a few days before delivery would have been required 320 million got canceled,,no one really wanted that oil, they only wanted the profit from the move in price. The problem with most of these instruments is no one ever has any intention of taking delivery,,, and it's not so much the little traders causing the problem it's the big money running things up,,, banks, hedge funds, our own govt, other govts, big corporations,,,, do you really think Chrysler is subsidizing the remainder of their 2.99 offer?

 

[js5020]

Oh just a tid bit of information,, did you know there is a commodity that is illegal to be traded on the market in the US? A law passed around 1958 forbids the trading of onions!!!!!!!! WELL I"M SURE GLAD THEY PASSED THAT ONE!!!!!!!!!!!!!!!! Could you imagine the catastropic events that could occur in this country if someone was able to manipulate that commodity!!!!!!!!!!!! Might even have GLOBAL impications!!!!!

 

[jimg]

I see. So, if I understand correctly, w/ ag commodities as context, some one(s) orders a 'boat load' of wheat, corn or whatever ultimately causing the price to increase and then cancels delivery. At some point theyd sell these paper holdings for more than the original purchase to make a profit. Seems like this scheme doesnt work unless you can get the 'herd' spooked and running (buying your paper holdings in this case). Guess there must be no (substantial) repercussion for not taking delivery?

Meant to also add this to the original post which strikes me as a real non-starter -- '"In some instances farmers are being asked to pre-pay for inputs they will not utilize until the next crop year", Stallman said. "This results in the uncomfortable position of producers locking in future input costs w/o similar opportunities in future crop prices."' Uncomfortable??? Thats an extreme understatment! Who would do such a thing? Perhaps theyre counting on the govt to provide relief in the form of price supports if things go wrong?

 

[mjarrels]

Some folks do take the item... I've heard that is one of the things that make Southwest Airlines so proffitable... They are not paying current fuel prices because they bought and held fuel at 80 dollars a barrel.

mark

 

[js5020]

Yes you got it,,, and with the decline of the dollar which we have to throw in there cause it plays big time with everything,,, you have the "herd" spooked. Far as I know there is little to stop the situation as things are,, oh yes there are daily limits which have been imposed to stop a quick run on things, but as I see them it just means when limit up/down is hit everyone takes the rest of the day off and we do it again tomorrow. I don't trade commodities or futures so I don't know all the ins and outs but it does seem a little like currencies, which I do trade everyday. So here is what I was doing today for an example to the above,, I was selling the Austrailian dollar and buying the Japanese yen,,, do I want either of these,,, heck no what am I gonna do with them? I just know and my charts are telling me to sell,,, why is it going down,, hmmm not sure,, but bigger money than me says sell so we sell,, around 1 pm things look like the interest to sell have deminished so we cash in,, nice profit for the day! Currently there looks to be an interest to buy, so we buy some, why? cause the little candle thingys are green and going up,, why? hmmm once again not sure, they just are. I'm kinda making jest here as I described the days trading but it kinda describes it well in my mind, you see as a speculator I really don't care if we go up or down, by how little or how much just as long as I get mine. Sorry if that upsets some, didn't write it to upset, it's just the way it is and how money is made.

Inputs,, they are kinda playing the same game, except watch who you are doing business with,,, there are all kinds of "lock in your price" now opportunities/scams/schemes. These are not regulated in any way and I have heard of some taking the money and not delivering the product! Seems everyone is trying in some form to hedge there exposure in some form be it the producer or end user, we are certainly in uncertain times.

 

[Egon]

The basics are probably not to hard to understand. Transfer my money to your account and maybe?????

 

[js5020]

Nice one Egon!!! But even in fun I will tell you I do not trade OPM ( other peoples money ) I couldn't put anyone elses at risk I'd fell real bad if I would lose even a small part of it. Basically it really isn't all that difficult to trade for yourself, but it does take alot of time and effort to learn, and this is a stumbling block to many, as most who do get involved want to be a gajillonare in two weeks, and usually end up broke.

 

[Egon]

Yep; back in my younger days there were folks who wished to teach me how to play poker. Sad to say they never had much luck and I still don't know anything about the game??

 

[charlz]

The article states: 'While sky-high future contract prices cause many Americans to believe farmers are bringing home the proverbial bacon, the reality is that few farmers benefit directly from from the contracts advertised by the commodity exchanges.' Really! So who does benefit directly and how does the farmer indirectly benefit? To me it implies a middle man taking some for himself. How much of the contract price does the farmer get?

I don't do this for a living but will take a stab:

There is a middle man, the 'Market Maker', these are the people that 'buy' from the farmer and 'sell' to the end user (high level view anyway). As a farmer you are not going to sell your 50 acres of corn to some beef producer that needs 1 million acres worth, too much hassle for them to deal with 20,000 farmers. Market Makers have large amounts of money and are usually some type of investment fund. They consolidate the market and make it easier for big buyers to buy. They make money by creating a 'spread' between the two. Buy from the farmer at $2 a bushel and sell for $2.50 or whatever.

This can happen in 'layers' where you have regional buyers which consolidate the smaller farmers and then the big market makers consolidate the regional buyers, finally you are to a level where the big buyer just needs a couple of contracts to get their 1 million acres worth of corn.

Which is why the commodity prices you see are not necessarily the prices the farmer is getting.

 

[jimg]

Understood about firms that pool together the output of many farmers. However, I thought this was the function of a grain elevator.

 

[charlz]

Understood about firms that pool together the output of many farmers. However, I thought this was the function of a grain elevator.

Yep, a big grain elevator would be an example of a regional buyer. They may contract with local farmers or you may get their 'spot price' when you pull up with a load.

The elevator actually takes possession of the product and then sells futures contracts (commodities). They pay the farmer X, load it into the silo's and wait until the price (hopefully) goes up and then sell it for Y. The difference is their slice of the pie. Some are run as co-op's so that the farmers get a piece of the Y price versus getting the X price.

Small elevators may get 'consolidated' by bigger operators or by investment types that actually just hold the contracts and do not take possession of the product.

The biggest thing I have heard about commodities is don't mess around with them unless you are absolutely sure of what you are doing With Ag crops there is seasonal variation, quality of harvest variation, crop destruction, bumper crops etc etc all affect the prices.

 

[Skerby]

maybe this will help you. if your a farmer and plant 100 acres of corn, you can 1.) expect to sell it when it is harvested to the co-op at the spot (or current) price they're paying. or you could 2.) have a grain bin and dry it out and store it and sell it when you're ready to take your spot (current) price from the co-op determined by supply and demand. you can also 'hedge' your profits by selling your corn in the futures market (just a financial instruent that is cash settled, no corn need be delivered) then you lock in price and if corn goes up when you harvest your contract would have gone down and visa versa... so you're just trying to lock in a particular rate and offset the price volatility through the futures contract.. speculartors are seeing it as a financial instrument just like microsoft stock, they buy thinking it will go up to make a profit and their "demand" for the contract influences the futures price.. but supply and demand for the underlying commodity at spot should be pretty fair...

 

[Skerby]

say you plant 27 1/2 acres of corn, that will yield about 182 bushels / acre on avg, hey, that's roughly about 5000 bushels! whad-ya-know! CBOT has a 5000 bushel corn futures contract! lets say our corn is maturing and sellable at market in september, lets sell the sept contract on margin @ 695. (695 cents per bushel) and raise roughly $34,750. when our corn matures, if corn went up, our contract price went up and we lose money on our margined contract we have to buy back at a lose to purchase, but we make up the money in the grain market selling our 5k bushels to the co-op. if the corn price went down, we'd take a hit with our crop at the spot grain price, but we buy back our margined futures contract at an offsetting profit.. this is the simple example of how this works for a farmer to hedge, of course you can see the difficulties, what if you don't get rain? lower yields etc.. that's why your a farmer, to be better able to forcast this stuff.. if your plant hundreds of acres, try you hands at the math and get a contract or 2 and work out your best plan to hedge your profits.. hedge is again to just lock in profits not to make a lot of money through specuiation, which is also much more risk..

 

[js5020]

I concur with the above don't mess with this stuff unless you really know what you are doing and fully understand everything especially the RISK end!! If it's anything like spot gold/silver you can be wiped out literally in minutes! Little story on this,,, the broker I trade currencies with had added spot gold and silver,, well silver was on a climb and everyone was "cashing in" and life was good,,, until one evening, the price of silver started dropping and dropping fast,, oh yes these were experienced currency traders they had stops in place, they were safe,,, or so they thought! Commodities when they crash tend to price gap,, price hopped right over their stops and they were filled at the best price the broker could get for them,, many at tremendous loss,, one guy who "owned up" lost 10 k in 15minutes,, a few others lost entire accounts,,, everything in a few hours,,,, luckily for these traders the broker uses a "no negative balance" policy, which basically meant the traders didn't get a call the next day asking for the remaining loss!

 

[Egon]

Learn to play poker with an empty pocket!!

 

[jimg]

To be clear I have NO intention of playing the commodities market. As per my original posting I just had some questions about the article b/c I really dont understand how it all works. Thanx to the very good answers I have a much better understanding.