FM: Not only has the production shifted globally but so has processing. What is the percentage of crushing plants outside the United States today as compared to say 25 years ago?
Haar: In the current year, the world crush is estimated at a little under 200 mmt, 47 million in the U.S., 69 million in Brazil, 46 million in China. When you are talking processing, the big change has been the growth of China, which is far and away the largest importer of soybeans in the world now.
The economics behind processing, once you strip away any distortion created by government subsidies, become a question of demand for meal and oil; if there is a demand for both, then it is more economical to import the beans and crush them locally.
FM: On the commercial side, have the main players changed much in that time frame?
Haar: There has been consolidation. You have the major players: Cargill, Bunge and Dreyfus. The most radical change since I came into the markets has been the big player in the grain markets had been the Soviet Union and other countries in Eastern Europe. A lot of the trading was exclusively in the hands of government bureaucrats on the buying side. You had a much more concentrated market in term of the buyers. Now that virtually every place in the world is in a fee-market mode, by and large those government entities have either disappeared or become a minor part of the trade, so it has created a larger mix of players and more balance between buyers and sellers.
FM: Those former Soviet republics have ramped up their production, haven’t they?
Haar: If you want one of the best textbook case studies in the world on the benefits of having the means of production in private hands, as opposed to a socialist system just look at agricultural production in the former Soviet Union. Basically you did a round trip because [during] pre-Communist days back at the end of the 19th and beginning of the 20th century, Russia was an exporter of grain, [but] then because of the degradation of the whole production process when farming came in the hands of communes, Russia [became] a major importer. They were unable to produce enough food to feed themselves. Here we are now, not many years later, and Russia has returned to its classic role as a major grain exporter, especially in the wheat market. Same thing with Ukraine and Kazakhstan.
FM: Long only commodity funds have been around for a long time but since around 2005, the money benchmarked to them has grow exponentially. Talk a little bit about their impact on commodity markets.
Haar: We are not going to put the genie back in the bottle but clearly the growth of those instruments has created problems for the markets. You have to go back and understand why commodity markets exist. They don’t exist to create an additional form of betting on a certain price level, they exist to allow commercial hedgers, producers as well as consumers, a place to meet and lay off price risk with speculators adding liquidity and intermediation when there is a timing mismatch from when the sellers want to sell and buyers want to buy. But what has happened with the growth of these long only funds is they’ve taken a permanent position in the marketplace, which has never occurred before, in terms of the role of non-commercial participation in the market and it has created some distortions and has created some problems.
Investors in those products over time will realize that this is not the way to approach commodity products. Commodity futures are a totally different class of financial instrument than say stocks or bonds that, in the case of bonds, generate interest while you are holding them you hope to get your principle back as well, and in the case of stocks , you are talking about an ongoing economic entity that underlies the stock, mainly a company which is ideally generating on a daily basis profits that eventually accrue back to the shareholders. A commodity returns nothing. A bushel of wheat, if you buy it and don’t do anything with it, is going to lose value over time because you have to pay storage to hold it. It is nothing that is ever going to generate any value on its own and that accounts for the normal term structure that exists in futures markets, which is carrying charges that reflect that cost of holding a physical commodity. That in turn is going to flow through to these long only index holders.
Some of these products have [had] negative returns since their launch and I think it is only a matter of time before investors get tired of losing money on these products which is almost inevitable unless you get a permanent hyper-inflation cycle in place where the price of everything goes up. Even then, they probably wouldn’t be the best instrument to capture that kind of inflation. There are plenty of others out there that are better suited.
The CFTC shares some blame for granting hedge exemptions on index swaps that really shouldn’t exist.