Bittersweet Taste: Price Discovery Can Be a Messy Business

Price DiscoveryThis past week Southwestern Ontario was inundated with 3.5″ of rain in one day effectively putting an ending stamp on the crop tillage season.  For those of us with the crop in the bin it was a bullet dodged but for those with corn still in the field it was a cold slap in the face.  The 2011 growing season came with many rewards but local rainfall records have been broken.  With about 30 days left in 2011, in some parts of southwestern Ontario we have never had more rain than we had this year.

We are not alone in southwestern Ontario, as of last week in Ohio 25% of their corn is still out in the wet fields. With snow starting to be in the forecast, that’s never good.  I hope producers get some uncommonly good December weather to push harvest to a 100% finish.

When the harvest end comes there is surely much to think about.  Many people contracted their crops at very handsome prices and surely there are many who still have grain unsold in the bin.  Market action over the last several months has been one of lower grain prices brought on by the exit of noncommercial demand in our agricultural commodity markets.  Getting these large speculators back in the market is job one, but the world has changed and it seems unlikely.  There is a general skittishness in the grain complex, which is so different than a year ago.

The MF Global scandal is turning into a very significant event.  Money that was used for hedging and was apparently not segregated properly and of course whoever was minding the store with regard to regulation left the hen house door open.  This has caused a tremendous loss in confidence in the US futures industry.  How does $1.2 billion go missing without traders, farmers and others not doing a double take?  It makes no sense.  Price discovery has to be better than that.

In many ways, the MF global scandal tells us that we have not learned very much since Lehman Brothers went under in 2008.  For instance DTN’s Chris Clayton this afternoon published an excellent piece on DTN “Senators Probe MF Global.”  In that piece Chris writes about an accounting loophole that MF global used to buy European bonds.  The bonds actually appeared to account for several times more than appeared in the company’s entire market accounts.  In other words, the books were cooked big-time and the CFTC, the CME and others in the US government let it go.  We still don’t know the truth, in fact fraud is probably committed but we do know there was real chicanery in the price discovery process over the last several months in Chicago.

For Canadian producers it should be a difficult pill to swallow.  We don’t like scandal in our price discovery process any more than anybody else.  However, historically we have always looked the other way when things go awry at the CME.  There’ve been numerous times in the past when I have written about problems at a futures exchange when eyes glaze over.  In fact, it’s almost like everybody is afraid to admit that a grain futures market might have a few problems that could adversely affect us.  I think that sentiment is quite strong in Canada, because essentially we are powerless to do anything about it anyway.

This past summer I had the opportunity to tour the CME trading floor.  I must admit that it was quite a thrill for me.  I never do things straight up.  I was visiting relatives near Chicago when I simply announced on Twitter “I was here”.  I sent out a tweet to the CME that I would be coming and wouldn’t mind a tour.  In this new world of communication, that worked and a few hours later I was admitted into the trading area at CME.  Yes, it was a thrill but it was also a bit underwhelming as computer trading takes up all of the action.  As the traders stared down on their iPad like devices strung around their necks, millions of dollars were being traded each second.  I’m sure even MF Global traders might’ve been there.  So in the short time I was there, how would anybody know if money was disappearing and chicanery was taking place? It’s very difficult to regulate something that happens so fast and you can’t really see.

In the intervening time over the past few weeks I have had some Ontario producers ask me about the effect of MF Global on our cash grain prices.  In my mind that’s a very positive development as its telling me Canadians are no longer willing to simply trust their grain futures price discovery mechanism.  However, there are not riots in the streets over the issue.  Needless to say, the money, which is gone, is gone.  There is a bittersweet taste wafting over farm country.

Prices for grain are down now, significantly from August.  Yes, it is a long story; many of us have seen it before.  However, what we have not seen is a brokerage company betting on European sovereign debt, calling their liabilities an asset on their balance sheet while somebody runs away with $1.2 billion.  It makes me think we’ve had a bit of price snookering going on.  Hate when that happens.  Let it be a lesson for all of us.  Price discovery sometimes is a messy business and it takes no prisoners.  Let’s hope it’s on the up and up from here.

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