In the next few columns, I’ll review what makes futures and cash grain markets move. I’ll touch on fundamentals, futures markets, technical and speculation. Then I’ll throw in some tariff and trade issues and add a little political mayhem, in hopes of trying to make sense of how markets act and react.
Market action starts with the fundamentals: supply and demand for a specific commodity, and for related commodities that can be easily substituted. Yearly production of a specific grain influences when buyers will buy, what they will buy, who or where they will buy from and what they’ll be willing to pay.
Supply and demand reports from organizations like the United States Department of Agriculture (USDA), the Australian Bureau of Agriculture and Resource Economics (ABARE) and Statistics Canada are followed closely by world buyers and sellers. Whether you believe them to be accurate or not, the world grain trade uses these reports as part of their purchasing and selling decisions.
When you’re reading these reports, the key numbers to watch for are: total production, carry forward stocks, year-end inventories and stocks-to-use ratios. These numbers, and year-over-year changes in these numbers, will help you to determine if world inventories are increasing or decreasing, if stocks will be in tight supply by year end, and what percentage of annual demand will be carried forward.
If it were only these “fundamentals” influencing grain markets, buying and selling grain would be a far simpler process for all involved. But it’s not that easy.
The next areas to watch are commodity futures trading markets. These markets have been in use for hundreds of years. They were created to enable buyers and sellers of a commodity to transact business on a local, regional, national or international level for future delivery, and allow them to establish fair market values with a transparent open-bid process.
More moving parts
If you only had to worry about fundamentals and futures markets, you would be able to establish fair markets values pretty quickly, and you could sell at a price you knew was fair. Unfortunately, there are more moving parts.
Futures markets allowed prices to be set openly and efficiently, but at times the amount of trading done in these markets was low or non-existent. For futures contracts to be relevant for business and establishing prices, a minimum trade volume was needed. Speculation was added to futures markets.
“Speculation” is the ability to trade a commodity on paper and finalize the transaction prior the delivery date of the contract, making money from a change in the commodity value without actually buying or selling that commodity.
Speculation allows those with money (who were bored) to invest (play with) their money, guessing what the markets will do, and making more money while having fun and keeping occupied (out of other trouble).
Introducing speculation increased trading volume in futures markets, allowing markets to remain valid and relevant to “true” buyers and sellers. But speculation also brought more price volatility to the markets. If prices aren’t fluctuating over time, there is no real risk to buyers or sellers inspiring them to buy and sell futures contracts and pay commissions to do so. They would just buy and sell as needed on a cash basis, knowing prices would likely remain steady. For futures markets to have value, there needs to be market volatility and price fluctuation. Futures contracts can be used to secure sales or supplies, and lock in and protect prices.
Over the years, speculation has become a critical part of futures trading, bringing billions of dollars of liquidity into the markets and helping to keep futures trading alive and relevant.
Speculation is of such large volume that it can create extreme volatility and cause major commodity price swings. It is a key factor to follow if you want to understand futures prices.