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Volatility and Risk in the Marketplace

By Ken Root

Some of us hate sudden up or down movement of prices and some love it.  Watching the market seek a new price in changing situations is both scary and exciting, be it grain, livestock, energy or currency.  The challenge of hedging or speculating, in a dynamic market, is the risk associated with every action or inaction. 

I recently spent a day in Chicago at the CME Group which now takes in both the Chicago Board of Trade and the Chicago Mercantile Exchange.  The goal was education of journalists about the workings of the markets and their derivatives.  I took a young associate along, who is in his first year as an agricultural broadcaster.  In comparison, I have been reporting on markets for forty-four years.  The difference in us is that I have historical perspective and he has youthful acceptance and quick grasp of concepts.  As we talked later, he viewed the day of education and market trader interviews as “baseline” with all past events as irrelevant.  I viewed it almost the opposite as my baseline was 1972 when the Russian Grain Deal happened and the roaring years of that decade followed by the Farm Crisis, beginning in 1979, and the deep rural recession that followed.   

I have come to the conclusion, regarding markets, that history can only teach you so much.  We find ourselves minimally capable of predicting the future, no matter what our baseline may be, but there is a strong correlation between decision making paralysis and extent of historical experience.  In other words: “The young bet big and the old bet small.”  We are more interested in keeping what we’ve got than risking it to gain more.

The market doesn’t care.  It loves volatility.  Commodities become attractive to investors if there is money to be made in short order.  In spite of the realization that futures trading is a negative business: “For every dollar made, there is a dollar lost plus commission.” Still, commodity funds bring great liquidity to the market by scooping up thousands of contracts near the beginning of the month and reversing out of them at the end.  Independent speculators, as well, shy away from a market that only moves a few pennies a week as it is not worth their time and effort.

Commodity traders, grain companies and bankers have become attracted to “options” on grain and livestock contracts in recent years.  The value of the option is paid upfront so the exposure is known versus holding an open contract that may require margin to be paid in the thousands of dollars if it starts to move in the wrong direction.  A farmer who wants to sell his grain and then re-own it in the futures market would buy a “call” at some future date when he thinks the market will be higher.  The farmer’s advantage would be to get rid of storage cost and capture additional profit if the market goes higher.  If he is right, in the life of the option, he can recover his option investment and make additional money.  You can even brag about doing this at the local café.

For some professional investors, the spread between commodities, or between contract months of a single commodity, can make money but knowledge of the market is a prerequisite before doing this type of investing.  In fact, shooting blind in this market will almost always result in a loss.  But knowledge without action still yields nothing.

The commodity trading companies and the infrastructure of the CME obviously want more volume of trade.  Their products are diverse and complex but the greater the skill and discipline of a grower or speculator, the greater chance that the desired outcome can be achieved.   

This year, the corn market began to increase in value due to the likelihood of a La Nina weather event.  So far, it hasn’t happened and the quality of the growing crop this week is the highest since 1999.  Those who were looking for a spike in the market due to weather have lost, so far.  The vote in Britain to leave the EU was manmade news that impacted the market for only a few days.  Now we turn to midsummer issues that range widely.  In a year with so much activity from terrorism to election campaigns, it is hard to say what will move the markets.  Many who take a futures position will find it worthless at some future point but have insured themselves against a major loss.

Orion Samuelson, the senior member of our delegation, was asked to speak of his memories of reporting on the Chicago trading pits as he has seen them over the past fifty-six years.  He talked about the “characters” who worked in the open outcry marketplace where hands waved, voiced flared and papers flew on days of volatility.  He admitted the current electronic trading was more accurate and much quicker but he still had a longing for the days when men faced each other and made trades, then sent them on scribbled cards to the accounting office to be squared by day’s end.  His final observation was of an old speculator who talked often about the marketplace.  “Keep in mind always that bulls make money, bears make money but pigs get slaughtered!” Orion Samuelson Full Audio