Bias Against Futures: I received an email several weeks ago from a reader; the subject line read: “my bias against futures contracts.” The message included a link to a column highlighting the recent decline in open interest in CME’s live cattle futures contract—primarily, the change in managed money positions following the recent financial market selloff (Aug. 5).
That was a broad risk-off day across all markets. The VIX spiked to levels not seen since Covid while the S&P500 plummeted 3% on the day. Futures contracts got swept up in all that. CFTC’s Commitment of Traders report (summarizing positions as of Tuesday, Aug. 6) reflected that reality.
The column was matter-of-fact. So, I responded, “…you’ll have to give more context in what you’re thinking here…what is it that’s troubling you about this?”
Too Many: The response back read like this: “In recent weeks or even months, there is little relationship between futures prices and what is happening in the real world. This is true for both fed cattle and feeder cattle. There are too many people making decisions in the futures market that know very little about cattle.”
Conundrum: Now I’m really confused. The first email essentially was calling attention to there being NOT ENOUGH speculators (i.e. funds) to support the market. And then when asked about it, the second email explained there are TOO MANY speculators influencing the market. Which is it?
Speculators: None of this is really new; it’s an enduring theme for some (see Bashing The Speculator). But don’t take my word for it—let’s turn to Dr. Scott Irwin, University of Illinois and his recent book, Back To The Futures:
Because speculators buy and sell contracts for products they don’t own nor have a hand in producing, they have a reputation as rogues, trying to make a bundle at others’ expense in the market. In the 19th century, critics said speculators traded ‘wind wheat’ because they didn’t actually grow or own the wheat. They were trading the wind. You can understand why speculators were seen as a bit shady. After all, how do you trade something you don’t physically own? A speculator’s purpose has confused people from the beginning.
Risk Transfer: Irwin’s book also includes observations from Dr. Craig Pirrong, University of Houston, who explains that, “Futures markets are all about the transfer of risk (emphasis mine). That’s something most people can’t get their heads around. The important function of speculation is that it allows risk to be transferred to the people who are willing to bear it.”
Dr. Pirrong further explains that whenever people don’t like the market, they often “…look for villains to blame…many believe they must find culprits with human faces.”
Pot Meet Kettle: My reader’s email went on to say: “One backgrounder took about 300 feeder cattle to a sale today and has about the same number consigned for Friday…They did this because the futures made no sense to them.” That’s code for, ‘he doesn’t like the price action.’
The irony here being that Mr. Backgrounder is, in fact, a speculator himself. That is, he’s long the physical market in hopes of profiting from market fluctuations (the very definition of a speculator). He’s a willing participant in the game of risk.
Don’t Blame The Futures Market: Mr. Backgrounder must believe he possesses some unique foreknowledge on how it would all play out. But not so much; the let-it-ride strategy didn’t turn out in his favor.
Given that truth, he would’ve been better off using the futures market, per its intended purpose, as a risk-transfer tool (or options or LRP or forward contracting). And in this instance, there’s been plenty of opportunity to do so, versus just bettin’ on the come (see chart at end).
Sure, I get it—your check didn’t play out like you initially hoped. But don’t blame the futures market.
Story brief: Futures markets have always been a source of consternation. The reason for angst generally falls on the speculators, but that blame is often misplaced.
