My previous column addressed some recent commentary regarding the state of the futures market (emphasis mine):
CME cattle futures are paralyzed and penalized by the algos and the high frequency traders who focus on geopolitical unrest and a soaring corn market to add to volatility and uncertainty….What once was a viable and sensible risk management tool has been turned into something barely recognizable. Many who trade cattle futures know nothing or their fundamentals and action is many times dominated by money flow as large positions are rolled from one month to the next dominate price movement.
My prior discussion focused on the “volatility and uncertainty” portion highlighting the fact that volatility is running near all-time lows. But there’s more to unpack here.
Specifically, the negative portrayal of speculators in the market. That’s nothing new - especially amidst turbulent markets; speculators are always the villains. But that spills into allegations of the entire system being broken: futures are no longer a “viable and sensible risk management tool” because they’ve “been turned into something barely recognizable.” How do we make sense of this?
Let’s approach it from the perspective of a cattle producer. And we’ll begin by exploring the core principles – focusing on the respective role of speculators versus hedgers in futures markets. In this case, the speculator is a buyer, taking a long futures position with the expectation prices will rise in the future. The hedger (seller) assumes a short position on the other side; he/she is buying insurance from, and transferring risk to, the speculator – an endeavor to protect against falling prices. All that occurs simultaneously: for every buyer there must be a seller and vice-versa.
Let’s turn to the CME’s live cattle futures contract to see how these principles play out in the real world. The associated graph details producer (short) and speculator (long) weekly positions (futures and options combined), respectively. A couple of key take-aways to note:
- As noted, opposite sides of the market work in lock-step with one another. It’s a perfect dance: producers can’t hedge price risk without speculators on the other side.
- The aggregate producer short position represents roughly half the cattle-on-feed population – and has remained relatively steady over time.
Sure, maybe it’s true: “many who trade cattle futures know nothing…” Does it matter? Knowledge and experience have never been a trading requirement. Simultaneously, do speculators and traders create volatility and noise in the markets? Yes. But it’s always been that way.
Therein lies the opening for risk management. And by all indications, cattle feeders are doing just that. If the system was truly broken cattle feeders would have established some other means to offset risk. But they haven’t; they’re actively using the CME to sidestep “geopolitical unrest” (and plant fires and Covid).
Griping about traders and speculators is a strawman. Much of it’s likely sour grapes about being out of position when the market turned. Whatever the reason, it doesn’t match reality; cattle feeders aren’t “paralyzed or penalized.” To the contrary, CME’s live cattle contract indeed remains a “viable and sensible risk management tool” enabling cattle feeders to protect their equity. Most importantly, that has positive implications for all producers in the industry.
Nevil Speer is based in Bowling Green, KY and serves as Director of Industry Relations for Where Food Comes From (WFCF). The views and opinions expressed herein do not necessarily reflect those of WFCF or its shareholders. He can be reached at nspeer@wherefoodcomesfrom.com.
