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Market Plus: Jul 11, 2008: John Roach

posted on July 11, 2008


Market Plus: Jul 11, 2008: John Roach Pearson: Welcome to the Friday, July 11th edition of Market Plus here at our Market to Market Web site. I'm Mark Pearson. With us this week our senior market analyst, John Roach. A lot of things to cover, John, and we covered a lot during the show. At the tail end you brought up those index funds. There's been a lot of concern, I would say a great deal of interest about what can happen if they change some of the regulations from the CFTC on commodity trading. I know you follow this very closely.

Roach: Mark, it's not actually a changing of regulation. It's actually the changing of the interpretation of the regulations. If one of our listeners would go to the CFTC Web site and look under speculative limits and look for exemptions to speculative limits each one of the markets has a – first of all, the purpose of the CFTC is to prevent anyone from cornering the market or to prevent them from moving prices just to profit for themselves because they're so big. So, we control the size of each trader who is a speculative trader in each market. And the size of the market determines the size of the limit. If it's a small market they can't own as many contracts as if it were a large market such as a foreign currency. There are exemptions granted, however, for those people who operate in the business and they're called hedgers and in the grain business that would be a grain elevator, a feed processor, a livestock producer. But there is, if you look under the exemptions on the CFTC page you'll see that there are some specific rules that you have to follow in order to be granted exemption. And it's really tied to the cash market and in the case of grains it's tied to the cash grain market. And what has happened is that rule has been interpreted to also mean an index fund. Since I am selling to someone else the ownership of index fund I should be able to hedge off that risk by buying futures. But the difference is that the size of money that has moved into these index funds and the potential size of money moving into the index funds can overwhelm our commodity markets. I'm not suggesting right now that these index funds have really done that in our agricultural markets. I don't think they really have yet. But the potential is there. And quite frankly these indexes are the only thing that are going up in the whole marketplace that I can see. And typically what happens, just as it happened back in the dot.com, high tech era, when something is trending higher more and more money gets piled into it. The commodity market, all the lists of commodities in the United States in exchanges is about $1 trillion worth of value. And if you compare that to the list of stocks in the United States it's about $13 trillion. So, it's $1 trillion to $13 trillion. And the you look around the world and you have a lot of other money around the world and most all that money, if it wants to participate, can come to our commodity market as an exchange traded fund or an index fund. And so the CFTC is holding hearings, Congress is holding hearings and I think this is important to agriculture producers because, as an example, in the case of hogs the entire ownership of the hog market is in the hands of the indexes. The commercials are short and the big spec traders are short and the small spec traders are short and the indexes are the ones that own it all. So, what would happen to the hog market if the regulations were redone and index funds were required to reduce the size of their long positions? And we think that's one of the biggest concerns we have right now from the standpoint of what could go wrong in this big bull market and it would be simply a changing of the way the rules are interpreted.

Pearson: Should that happen, John, the pressure would that extend to just beyond the pork complex? The indexes are in every commodity aren't they?

Roach: They're absolutely in every commodity. Most all of the index funds that you see have various percentages of commodities from energies to agriculture commodities to meats to base metals to precious metals. Each one of them has their own kind of percentage the way that they're put together but they're all designed the same way. They're designed to make money in rising prices. And the more money that goes into those funds the more it tends to raise prices and that's what Congress is looking at right now. Is that causing inflation that we should not be having? As an example, in the energy markets right now there's about 90 days of supply that's owned by the speculative trade. Whether that is something that should be allowed or not they don't know. But it certainly should be controlled under the speculative limits.

Pearson: That's going to have a big impact on commodities, it could certainly deflate commodity prices to a certain extent because commodity prices are virtually all long positions. Is that correct, John?

Roach: They're virtually all long positions. There are some that are on the short side but they're virtually all long positions and if there's a change then you can expect to have the market be rocked by that. Or if it appears like change is coming you can expect the market to be rocked by that.

Pearson: Just real quick I want to talk specifics on corn and beans. Producers are out there still scratching their heads saying, you know what, additional weather problems, could this thing go higher? There's going to be concern about early frost because of the late plantings in many parts of the Corn Belt. At this stage of the game, what percentage would you have sold for 2008? And also you're one of the few analysts who were saying, hey, take a look at '09 and '10 and maybe get some of these sales made now because your input costs are going to be staggering over the next couple of years.

Roach: There's really two ways of looking at markets. One is for an analyst to sit here and tell you that they think they know how high prices are going to go and when it gets to the top I'll tell you when to sell. I'll hire that analyst if they're really very good at it. The other person says take a look at your business operation and that's me. Look at your business operation and see how your business is doing. We really can't predict prices but you sure can predict business' profitability if you'll get your pencil sharpened up and start calculating. We're to a point on our crops most every listener out here who is a farmer is going to have a crop. That crop needs to be sold. And when you ask what percentage we've been suggesting to customers that they sell all the grain that they can feel comfortable and still sleep at night. And so basically we're saying be as heavily sold in this marketplace as you can stand. And as you look out to '09, again, get the pencil out, take a look at these higher costs. When you look at the higher costs and then you take a look at what the revenue per acre is out there and then you look at the new farm bill and you look at the kind of insurance it puts underneath of you at a lower level but there's still pretty good insurance there the whole bottom line is the best opportunity in agriculture is with us right now. And although we don't want to talk about it disappearing because we don't really see it disappearing we know in agriculture that that's exactly what happens. Producers around the world when given enough money can out produce the demand. There's plenty of acres to come into play. To give a corn producer a little bit of an idea, average corn yield around the world, except for the United States, is 60 bushels per acre. Fertilizer is going up, not because we're applying more in the United States, not because it's running short but because overseas buyers are buying it. Put fertilizer on 60 bushel an acre corn, you get a lot more corn.

Pearson: Absolutely, worldwide and, of course, the hybrids are hitting the United States and are being sold everywhere. Excellent points, as usual. John Roach, our senior market analyst with us here on Market Plus and on the show this week. From all of us here on Market to Market, I'm Mark Pearson. Have a great week.


Tags: agriculture commodity prices markets news