PEAKS IN 2008 AND 2011 AND
INVESTORS’ PARTICIPATION IN
FUTURES MARKETS
(Article by Frank S. Rose, College of Business, Lewis
University, Romeoville, Illinois, United States)
IntroductionIn 2008 and again in 2011, maize, wheat and soybean prices reached historically high levels, after long periods of uptrend. In the maize export markets1 in the United States,
price peaks of around US 7.90/bushel were observed in June 2008; in April 2011, peaks of USD 8.20/bushel were reached. Wheat prices hit USD 10.98/bushel in February 2008 and USD 9.50/bushel in February 2011. Soybean prices rose to approximately USD 16.60/bushel in June 2008, and USD 14.70/bushel in January 2011.2 Figure 1 illustrates
these peaks, the uptrends preceding them, and the
subsequent downtrends. Certain other commodity markets, such as crude oil and copper, experienced similar patterns of price rises and falls during these periods.
A number of short- and long-term factors have been cited to explain these price run-ups, including weather and supply problems in key production areas, a weak United States Dollar, growing Chinese demand for commodities, quantitative easing by the United States Federal Reserve, use of maize in ethanol production, and investor activity in the futures markets. In this article, without attempting an explanation of cause and effect, the last factor is addressed. We ask, “How does investor participation in the futures markets before and after the 2008 price peaks in maize, wheat and soybeans compare with their participation before and after the 2011 peaks?”
The next section discusses how four groups of futures market users, three investor groups and one non-investor group, would be expected to behave during the price rises and declines before and after the 2008 and 2011 price peaks. Then, we explain our data and analysis, and conclude with a summary of our results.
Expected Market Positioning of Four User Groups When Futures Prices Rise and Fall
In this article, we examine the participation in futures markets by four user groups, traditional hedgers, swap
1 Prices reflect cash basis f.o.b. US Gulf
2 One bushel of wheat or soybeans = .02721 tonnes; one bushel of
maize = .02540 tonnes
dealers, money managers and index traders. Traditional hedgers are not investors in futures but we include them for comparison purposes. They use the futures markets to manage risk, taking long (buy) positions to offset risks of price rises and short (sell) positions to offset risks of price falls. When prices are going up, firms needing to purchase the underlying cash commodity in the future would be expected to take long positions. Firms wanting to sell the underlying cash commodity in the future would be expected to take short positions at various points during the uptrend to establish ultimate selling prices for their commodity at the high current levels.
In recent years, investors, defined as those having no commercial interest in the underlying cash commodity, have been increasingly drawn to futures markets for several reasons. First, access has become easier, investors understand these markets better, and they are more comfortable using them. Second, the returns from investing in commodities have often compared favourably with returns from stocks, bonds, real estate and other investments. Third, commodities have been increasingly added to portfolios as a separate asset class to reduce overall risk.
Swap dealers use the futures markets for risk
management, but unlike hedgers, their participation reflects their provision of various investment products in the over- the-counter (OTC) markets. Typically, a swap dealer offers OTC investment products that commit the dealer to making a pay-out if commodity prices rise. For example, a dealer may sell a swap to an end-user, such as a wheat miller, that guarantees a wheat purchase price of USD 7.00/ bushel for a set quantity over a specific time period. If the miller’s purchase price rises above USD 7.00/bu, the dealer pays the customer the difference between the two prices in accordance with the terms of the swap. In this example, because it takes on a risk that commodity prices will rise, the dealer will hedge this risk with a long position in futures. Swap dealers also sell OTC products to financial investors which see or expect an upward trend in prices and similarly hedge these price risks with long positions in futures. Finally, because of the preference of some investors to maintain continuous price exposure to commodities for portfolio diversification purposes, provision of OTC products to these “long-only” investors requires the swap dealers to hold constant long positions in futures to manage their risk.
Money managers trade on behalf of customers and seek profit opportunities in futures relative to other investments. If commodities are outperforming other investments, they will increase the allocation of futures in their portfolios. They are not passive long-only investors. One would expect these participants to be long when price rises are anticipated and
price uptrends are established, and short when price declines are expected following price peaks.
Index traders are those whose investments in futures are based on commodity indexes, which are based on a defined composite of commodity futures contracts. Activity levels in this user category reflect transactions of those swap dealers who provide their customers with index-based OTC products. The category also includes money managers such as pension funds which may replicate or create commodity indexes as part of their trading activity. Index traders generally would be expected to be long in rising markets and short in falling markets. However, the category also includes the passive traders, such as those noted above, who continuously maintain long, index-based positions for portfolio diversification purposes.
Analysis and Data
Graphs on page 62 show the price rises, peaks and declines for the past five years in the United States maize, soybean and wheat export markets. We focused on the price peaks in 2008 and 2011, and took snapshots of market participation of the four user groups at the following points in time, i) the beginning of the price uptrend which led to the peak; ii) one month prior to the price peak; iii) the price peak; iv) one month after the price peak; and v) the end of the downtrend following the price peak. To illustrate, with respect to the maize price peak in 2008, we took five snapshots, i) mid-July 2007 when prices were at USD 3.76/ bushel; ii) end of May 2008, prices at USD 6.23/bushel; iii) end of June 2008, prices peaked at USD 7.90/bushel; iv) end of July 2008, prices at USD 6.23/bushel; and v) early December 2008, prices at USD 3.35/bushel. No data points are reported for the end of the downtrend following the 2011 peak because we do not know if there will be an extended downtrend and, if there is one, when it will end.
For each of the snapshot points in time, we compiled data on “open interest” (i.e. existing positions) of the four user groups in the CBOT futures and options on futures markets. The source of the basic data was the Commitments of Traders databases, specifically the Disaggregated and Supplemental reports, released by the United States CFTC. These databases provide disaggregated open interest data which have been submitted, as required by CFTC regulations, by futures and options traders holding large market positions. We compiled the total long positions of each user group, the percentage of total long positions held by the group, and the net long (long minus short) positions of the group.
The results of this compilation are summarized in Tables 1-3 (pp 63-65). The open interest information for each
user group is reported in contracts (5 000 bushels/contract). Note that the traditional hedger group is called “Producers/ Merchants/Processors/Users” in the tables, following the category name used in the CFTC’s databases.
Summary and Conclusions
Several observations may be drawn from a perusal of the tables. First, although our focus is not on the traditional hedgers, it is interesting to note that, as a group, their net short positions grew larger as prices rose and declined as prices fell. This suggests that a large segment of this group was creating short positions during the price run- ups to establish higher prices for eventual sale of their cash commodities.
Second, each of the three investor groups, swap dealers, money managers and index traders, increased their long and net long positions as prices rose and reduced them as prices fell. This is consistent with the expectations discussed in section II. This pattern is not as clear cut in 2011, particularly with regard to the net long maize positions of swap dealers, money managers and index traders (Table 1). Long maize positions peaked as the prices peaked in 2011, but net long maize positions of swap dealers and index traders, for example, actually declined steadily from the start of the uptrend in mid-June 2010 to the month after the price peak, mid-May 2011. This difference between 2008 and 2011 might be related, in part, to differences in other investment opportunities available during the two periods. In the run- up to the 2008 price peaks, the stock market was generally in decline, making commodity investments relatively more attractive. On the other hand, during the 2011 period, the S&P 500 was rising and perceived advantages of commodity investments during the price run-ups may not have been as clear.
It might also be noted that in each of the three futures markets, in each of the periods examined, total open interest (not reported on the tables) increased steadily as prices climbed to their peaks and then declined as prices dropped.
Third, during the periods at and around the 2011 price peaks, long and net long open interest levels of the investor groups were generally somewhat greater than observed around the 2008 price peaks. This was not universally true; for example, net long maize positions of swap dealers and index traders were lower in 2011 than in 2008 (Table 1).
Fourth, there is some indication that long positions are reduced by investors more quickly following the price peaks than they are built up prior to the peaks. Note, for example, the pattern of open interest changes pre- and post-peaks among the investor groups in soybeans (Table 3). However, as with our other observations, a more rigorous analysis
would be necessary before definitive statements could be made concerning this behaviour.
Fifth, the positions of the money manager group show a tendency to be somewhat more volatile than the other two investment categories. This might be expected as these traders, as a group, are more apt to shift their positions constantly in the pursuit of profits. Note, for example, the sharp increases in net long positions from the start of the uptrends in 2011 to the price peaks, 69 000 contracts to 322 000 contracts in maize, 12 000 contracts net short to 52 000 contracts in wheat, and 32 000 contracts to 169 000 contracts in soybeans.
The observation that swap dealers, money managers and index traders increased their long positions in the futures markets as prices rose during the periods examined and reduced their long positions as prices fell does not, of course, permit any statements regarding any cause and effect THE relationship between investor activity and price formation. However, the dialogue in the United States and elsewhere concerning this relationship has prompted the CFTC to re- examine its position limits; i.e. the regulations restricting the participation of non-hedgers in the United States futures markets. A brief summary of the CFTC’s recent work on position limits is presented separately.
0 3 6 9 2011 2010 2009 2008 2007 2006
USD per bushel
5 10 15 20 2011 2010 2009 2008 2007 2006 USD per bushel
0 5 10 15 2011 2010 2009 2008 2007 2006 USD per bushel