A growing discrepancy between US grain futures and cash prices must be corrected to help buffer exposure to volatile markets by exporters, processors and farmers, grain industry experts said on Tuesday.
The Commodity Futures Trading Commission hearing in Washington heard concerns about what farmers and grain users said was unprecedented malfunctions in the century-old process of "hedging" prices for corn, wheat and soybeans at the Chicago Board of trade, a CME Group subsidiary.
The situation is at point where country elevators and multinational grain companies will not buy grain more than 60 days out. That has put farmers in a bind - unable to project sales income for the upcoming harvest or prepay input costs.
"The bottom line ... is that delivery location basis in corn, soybeans, and wheat generally is weaker and far less predictable post-2006 compared to pre-2006," Eugene Kunda, a University of Illinois researcher, told the hearing, broadcast over the Internet amid widespread interest in farm country. "This has far reaching implications for hedging use of these futures markets if the situation is not corrected."
Hedging is the economic basis for "futures" markets, basically shadow markets to actual cash demand for commodities and geared to respond to the same fundamentals of supply and demand.
At the expiration of futures contracts, the traditional delivery process has allowed "convergence" of cash and futures prices. If futures are higher, cash commodities move into delivery and bring down prices. This allows a perfect "hedge," or risk offset, so that gains in one market are cancelled by losses in the other but a company's balance sheet is stable.
Hedged positions for decades have been the basis for loans to farmers and commercial grain users by banks, who use the futures positions as collateral for loans. Kunda presented studies to the CFTC that showed this convergence is no longer the rule. Critics point to many factors, from Wall Street "hot" money flooding grain futures and inflating prices far beyond real cash demand to transport factors or booming grain exports.
Grain users have howled for the last two years as CBOT has seen record price spikes in corn, wheat, soybeans and rice driven by a weak dollar, exports, biofuels demand and world crop losses. As futures soared, hedgers were bled by soaring margin calls to hold their short futures positions.
But with futures and cash not converging anyway, and banks drained of extra funds to finance positions of farmers or grain elevators, grain users are asking: why hedge? "The whole problem is convergence," said Garry Niemeyer a farmer representing the National Corn Growers Association.
"Elevators can't get the money from the banks because we don't have convergence," said Niemeyer. "We as farmers can't sell our grain." Grain speculators have often been the target of CBOT hedgers. The rising role of hedge funds and "index funds" from Wall Street remains under fire. Such funds have been attracted to booming commodities markets amid declines on Wall Street and in the US dollar.
David Lehman, CME Group chief economist, told the hearing that the CBOT has made some changes to its contracts, including raising the storage rates for corn, soybean and wheat which should alleviate some of the convergence problems.
CME also on Tuesday asked CFTC for permission to clear trades on over-the-counter grain swaps, an alternative to the CBOT's traditional futures hedges that grain farmers and handlers have been experimenting with to find ways to avoid the punishing costs of holding "short" hedges in soaring grains. "It's up to us to fix the issues," Charlie Carey, vice chairman of CME Group and former CBOT chairman, told the hearing.