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Market Controversies

Market Controversies. Futures markets Speculation Captive supplies. Futures Market Controversies. Long standing debate Speculative activity Occasional proof of manipulation Possible to trade more than is produced Close relationship between cash and futures. Range of opinions.

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Market Controversies

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  1. Market Controversies • Futures markets • Speculation • Captive supplies

  2. Futures Market Controversies • Long standing debate • Speculative activity • Occasional proof of manipulation • Possible to trade more than is produced • Close relationship between cash and futures

  3. Range of opinions • Organized gambling • Only perfectly competitive market in the country • Highly regulated

  4. Important Function of Futures • Price discovery • Risk transfer • Forward pricing

  5. Speculators • Speculators, Pro • Add liquidity to market • Assume price risk in hope of making a profit

  6. Speculators • Speculators, Con • May mis-price commodity because they are not farmers • Herd mentality • Large volume “Funds”

  7. Speculators on Average Lose • Zero-sum game • Gains = losses • Brokers are always paid • Beware of “sure-fire” systems • Difficult to beat the market • Why share valuable information

  8. Futures to Cash Relationship • Both are jointly determined by the same market forces • Futures are an anticipatory market and may change prior to the cash market giving the appearance that futures lead cash

  9. Futures to Cash Relationship • Futures incorporate information • Price discovery role • Large volume, instantaneous information interpretation may cause over reaction and exaggerate price fluctuations

  10. Does Hedging Work? • What are the objectives??? • Risk management: Don’t sink the ship • Price enhancement: Don’t miss the boat • It is a marketing tool to be used selectively to achieve specific objectives

  11. Potential Manipulation • Illegal and highly regulated • Commodity Futures Trading Commission (CFTC) • Limits on number of contracts held • Price limit movements • Difficult to accomplish • Hunt brothers

  12. Forward Contract Controversies • Hedge to Arrive • Captive supplies • Market power • See Captive Supply presentation • Long term contracts • Market power • Price discovery • Encourages expansion

  13. Hedge to Arrive (HTA) • 1995-96 corn market • Promoted as a way to capture “highest prices in years” • July - Dec spread was “too wide” and should narrow. • Sell multiple crops in one year

  14. Spread “too wide” • Sell the July now then if: • July goes down • Dec should go down less (narrow) • Buy back July and sell Dec • July goes up • Dec should go up more (narrow) • Buy back July and sell Dec • Gain from narrowing spread

  15. “Hedge” in July contract • Elevators offered HTA contracts • Elevator took futures position • Farmer was to deliver bushels • Spread did not narrow • July futures increased Dec didn’t • No crop in July - can’t deliver

  16. HTA • Elevator (often coop) had margin calls • No grain to make a hedge • Farmers couldn’t or wouldn’t deliver grain • Some had 3 crops sold well below the market

  17. Lessons from HTA • History is not a perfect predictor of the future • Understand contracts • Put everything in writing • Read all the writing • Properly used HTA can be a good marketing tool

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