A trader once told me that as long as you're on the right side of the markets they always make sense. If you're on the wrong side, they never make sense. Market bulls are always happy when the market is going up and bears are always happy when it's going down.
As we know, neither trend lasts forever. But after having been in this industry for nearly 30 years, I'm not sure I've ever seen a time where the price action was so dramatic in the opposite direction vs. what the fundamentals seem to dictate.
Therein lies an important issue in commodity price analysis. You've probably heard someone in the coffee shop say, “Prices shouldn't change this much. The facts don't change this often.” What's wrong with that statement is that prices aren't based on facts. Prices are based on what people think the facts are.
As the market moved into the month of February and soybean prices exploded for a $1.80 move to the upside, it was obvious that someone — or many — with significant amounts of money changed their mind on what they believed corn, soybeans and wheat were worth.
What caused such a price explosion — one that caught many traders, commercial companies and advisers (myself included) unaware that this huge price jump would occur? In particular, what caused the magnitude of this move? Has there been a dramatic change in the factors that affect commodity prices?
Change Is Inevitable
The answer to whether or not change has occurred in the markets is both yes and no. No markets are stagnant without a change of either the fundamentals or a change of the players “voting” on prices every day. The question I think is on many farmers' minds right now, however, is whether or not the “funds” have taken this market over.
It's important to keep in mind that commodities are a little different than stocks. In stocks individuals can buy and hold them forever without selling. That's not true in commodities. For every buyer there is a seller. That's how the contract is generated.
Price is determined by the equilibrium among buyers and sellers. The market in commodities is made up of many buyers and sellers. It's important to differentiate, however, that not all commodity funds are the same.
There are many commodity funds that trade in various commodities and will both be long and short at various times. In the last few years, for example, there has been an influx of what's called “index funds” where the funds are always net long commodities. As soon as the market gets close to expiration of the commodity they're in, that position is sold and they buy the next month.
The theory behind many of the index funds is that they're hedged against inflation. If commodity prices go down, they lose. If commodity prices go up, they win.
In the last few years there has been a change in the number of funds investing in commodities. This first started as a result of a collapse in the stock market beginning March 2000. Although the word commodity was a dirty word to many investors at that point, they have learned that there is as much or more risk in the stock market as there is in commodities. Last year the amount of money in domestic commodity funds doubled from 2003.
My guess is that the amount of money that has flowed into commodity funds since January 1 has been significant.
Commodity funds have returned their investors good profits over the last couple of years. Everyone seems to be getting in the game and those who didn't know what commodities were six months ago, now can't wait to jump on board.
The advent of commodity funds and additional cash flowing into the commodity market has added to the volatility of the market, which is both good and bad. This is a free world where people can do what they want. Let's not worry about who can trade commodities. We can all buy and sell stocks — why not commodities?
While some would like to think that buying corn and soybeans are good hedges against inflation, I don't agree because we can keep growing more of it.
In fact, this is a bad time of year to have a bull market in corn and soybeans because it will assure us of an extremely large planted acreage of both crops in the U.S.
It also helps bail out South American farmers who only eight weeks ago were staring at $4 cash soybean prices in Mato Grosso. This will keep the acreage stable in Brazil and barring major production problems in the U.S., the higher this move in corn and soybeans goes now, the lower it will be in July and August.
A former professor once told me that grain farmers in the Midwest have two crops to harvest every year — a grain crop and a speculator crop. This is a rally to be used in harvesting speculators.
Richard A. Brock is president of Brock Associates, a farm market advisory firm, and publisher of The Brock Report. For a trial subscription and information on Brock services, call 800-558-3431 or visit www.brockreport.com.