By Fred Evans – February 22, 2017
The idea for this blog was hatched following a discussion within our office about an apparent lack of interest by many young farmers to learn about futures markets and price risk management.
We asked ourselves a few questions:
– Will the next generation of farmers have the same depth of understanding about commodity futures as the outgoing generation?
– Are farmers as willing to hedge grain with futures contracts and use basis contracts now as they were nearly forty years ago?
– How has the industry changed over the years?
– What can we learn from the past?
In this article, we’ll explore these questions through an examination of the evolution of futures trading.
The dawn of the futures broker
In my last article titled “Then and Now”, I discussed how the Russian grain purchases in 1973 resulted in strong price rallies, the likes of which had not been seen before. Fortunes were made and lost by those who were involved with futures trading and the CBOT at that time.
However, prior to 1973 few people actually had a futures brokerage account, or had even been interested in the prices of corn, soybeans and wheat.
The Russian purchases changed all that.
In the city of London, ON, in 1973 there were one or perhaps two individuals who were licensed as futures brokers. The concept of hedging was something farmers read about in text books and the idea of having a brokerage account had never occurred to them.
But reports of million dollar success stories started showing up – and quickly spread. No one talked about the losses, of course.
People demanded to learn more.
Academia got into the act. A very young Dr. Larry Martin had arrived at the University of Guelph to teach agricultural marketing while Sean Usher taught the students at Ridgetown Agricultural College how to hedge.
The stage was being set to open up a new form of risk management and crop marketing.
Brokerage firms set up shop in Canada
U.S. brokerage giant Merrill Lynch had purchased the long established Canadian brokerage firm Royal Securities in 1969. By the mid 1970’s Merrill Lynch Royal Securities was expanding across Canada to smaller centres and brought with it commodity futures services. Merrill, at that time, was the largest futures broker in the world and its research division was considered second to none. The London office opened in 1978 and hired six men, including me, to be full-time futures account executives.
Within a very short period of time the other established Canadian Brokerage firms also made futures trading services available to their clients. By 1980 there were at least twenty-five individuals in London who were fully licensed to conduct futures transactions with clients.
Futures take the spotlight
The interest in trading futures was given a boost by the Hunt brothers who, in 1979, attempted to corner the world’s silver market. It only lasted five months but silver rallied from $11.00 per ounce to $50.00 before collapsing in January 1980.
Futures trading had become nightly news on television.
Farmers wanted to learn more about futures and grain marketing and one of the early sources of information was provided by centres of the Ontario Ministry of Agriculture and Food. One course, held in Stratford in 1980, was taught, in part, by me and a young farm reporter for CFPL Radio, John DePutter.
The Ontario Agricultural Training Institute offered two and three part courses for producers that taught them how to establish profitable marketing plans utilising futures hedges.
At least one of the major chartered banks was actually encouraging hog producers to open futures accounts to hedge their hogs. Interest rates were at all-time highs and margins were slim and the bank wanted to assure the profitability of its clients.
It would not be long, however, before the banks were discouraging futures trading by their customers.
Reality sets in: futures trading isn’t so easy.
Futures trading has never been easy. But in the 1970s, it was particularly challenging for producers, for several reasons.
For one thing – getting access to timely information was not easy. Back then, fax machines were uncommon and the transfer of information was painstakingly slow.
Those of us involved with grain marketing maintained our daily charts manually and many of today’s technical studies were unheard of then as PC’s did not exist. Some of us calculated moving averages, as they were easy to maintain, but they had serious limitations.
Unlike today, with futures charts available on various websites for a few simple clicks, keeping manual charts required time and discipline.
As a result, and as encouraged by the Ministry, producers formed Marketing Clubs of approximately 20 members with the aim of studying market fundamentals and technical indicators and hopefully developing confidence in trading. One club, northwest of London, formed in the late 1980’s continues to this day. One by one, farmers signed up with DTN and then had the latest up-to-the-minute information available in their home office.
Another challenge for producers was the amount of working capital a hedging account required.
As time went on, many got discouraged and gave up their hedging program.
No longer forbidden: The return of Options
By then the futures investment industry had resurrected the previously long forbidden Options market.
On the surface, options appeared to be the perfect solution to a producer’s desire to hedge without the huge financial risk associated with a futures contract.
If you purchased a put or a call you knew exactly what your cost was. Options had opened the futures markets to an entirely new group of traders and producers and the number of participants grew.
The exchanges were thrilled.
Competition intensifies; the game changes.
While the numbers of traders grew, the competition for their business became intense. The competition manifested itself in discounted commissions — a bonus to the customer but a long-term negative to the individual brokers.
One by one, brokers left the business.
Many of the brokerage firms decided that the risk associated with commodity accounts was no longer justified and they discontinued offering the service. U.S. customers of the once mighty Merrill Lynch no longer had a futures account executive in their local office. Instead they were given a 1-800 number to Chicago.
The personal service and strategizing that the broker provided had become a thing of the past.
Meanwhile, though, the re-introduction of Options opened up new avenues for hedging by producers. Chief among these were new types of grain contracts offered by local grain elevators and end users.
Minimum price contracts quickly became very popular and were followed shortly by the Hedge-to Arrive or Futures First contracts. Basis contracts had been available for many years but now, in conjunction with the new contracts, the producer could lock in the basis or the futures as he saw fit. Commissions were built into the price of the contract so it was not the same as getting a charge from your broker. As well, with the Hedge-to-Arrive contracts, the elevator company paid any margin calls on the producer’s behalf.
What a deal!
The Internet, the great equalizer
The Internet has played a huge role on the transfer of information to the agricultural community. Thirty years ago it was part of the broker’s responsibility to inform his customers of the fundamental information impacting the price of grain. That is no longer the case.
Today, USDA crop reports are conveyed instantly to all. The markets’ reaction to the report is immediate. The analysis of the data still takes some time but usually within 30 minutes a producer can have an educated interpretation of the numbers from an analyst, somewhere, via the internet.
As the broker’s role in the relationship with his customers transitioned from advisor/strategist to basically “order-taker”, the commissions earned on each contract fell.
For example, in the mid 1970’s a round-turn commission on one grain contract was $50.00 U.S. or one cent per bushel. That figure rose to $100.00 by the mid 1980’s before volume discounting and competition set in. When discount brokerage houses appeared, the commissions declined.
Futures trading comes full circle
The industry appears to have come full circle since 1970.
Today there is but one individual, to my knowledge, in London who maintains a license for futures trading and will offer hedging advice. A producer today is just as likely to open an account on-line and trade directly, avoiding any intermediary.
Fewer producers actually hedge or speculate in futures, instead concentrating on cash marketing decisions.
Young farmers are no longer knocking on our door, wanting to learn more about commodity marketing, even though some added knowledge has the potential to improve their sales and risk management decisions.
Trading futures still is not easy.
What does it all mean for today’s farmers?
Here’s our two cents.
– As mentioned, trading futures can be a tricky – and risky – proposition. The DePutter team does not encourage all subscribers to become actively involved in futures hedging or trading accounts. What we have always encouraged our members to do, is understand how futures function as price setting mechanisms and hedging vehicles.
– Even if you don’t want to hedge with futures, it’s important – and helpful – to at least understand what hedging is, and how grain traders and some farmers use hedging to manage price risks.
– Finally, a look back at history is always interesting. It can get us thinking with a fresh perspective about where we sit today. As Theodore Roosevelt said, “the more you know about the past, the better prepared you are for the future.”
– Where does Ag-Alert sit in all this? Well, throughout the period just chronicled, Ag-Alert has been providing timely marketing advice to producers. Starting as a nightly telephone hotline and then transitioning to an e-mail service with weekly newsletters and period special reports, Ag-Alert provides its customers with up to date market news, analysis and marketing strategies. So, while brokers and brokerage firms have come and gone over the past thirty-six years, Ag Alert, and its parent company DePutter Publishing, continues to provide its customers with timely marketing insight and strategies to help them achieve superior marketing success.
Fred Evans spent about 40 years in the futures and grain trading business. He now provides services as an analyst and commodity market researcher on a part-time basis for DePutter Publishing Ltd.
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