Stanley Haar, Haar Capital Mgmt
After graduating with a degree in economics and international studies from American University, Stanley Haar was a Fulbright Scholar in Brazil in 1971-72, where his research focused on the International Coffee Agreement. The experience in Brazil piqued an interest in commodities, and Haar went on to earn an MBA from Stanford with a concentration in futures markets and international trade.
After graduation, he went to work for Continental Grain in 1977 and has been trading in one form or another ever since. Haar worked on some of the largest commercial trading desks in the United States and in South America and became the commercial manager for Conti’s Brazil operation.
Haar also has worked in senior management positions at several major brokers and as manager of international business development for Franklin Templeton Investments, a global investment money management organization.
Haar says that working in the trading, exporting and processing side of the markets has formed the foundation for his trading experience and has given him an advantage in how to approach markets. He launched his discretionary commodity trading advisor Haar Capital Management, which focuses on agricultural markets, in 2005.
Futures Magazine: Stanley you have worked many years in both the cash and futures side of agricultural commodities. What are the main differences?
Stanley Haar: [There is] a misconception that people in the grain business on the physical side spend most of their time worrying whether prices are going up or down. When [you are] in that business you may have a strong opinion on the price direction that the market is going to take and have a speculative bet as part of your operations, but that is a minor part of the focus. The companies that have grown and survived over the years are ones for which the speculative part is a minor part of the activity. The main focus is on the relationship between futures and cash—the basis—most of the risk positions that you have are basis trades: export premiums, domestic premiums from the farmer, or if you are selling meal and soybean oil, the premiums you are getting from your customer relative to the futures market. [Also, there are] the concerns having to do with logistics: freight costs, transportation, availability of freight, which at times could be a nightmare particularly in places like Brazil or Argentina. If you are operating the processing area, your main focus is on extracting a processing margin which has little to do with the flat prices levels. The main thing you care about is the relationship between the price of the bean and the product. So really, you are running a business and the speculative positions related to the flat price tend to be a minor or insignificant part of the focus.
FM: Do people on the commercial side get themselves in trouble by focusing too much on the speculative side?
Haar: There is a whole graveyard of companies, many of them blew themselves up by focusing too much on those type of risk positions and not on the core of the business which is extracting margin on a regular basis while minimizing risk.
FM: When you began working on the cash side, the majority of production was in the United States. How has the global shift in production changed the market?
Haar: Back in 1985, world soybean production was a little over 100 million metric tons (MMT), of which 57% was in the United States and 25% was in Brazil and Argentina. Now in the current crop year, world production is estimated to be 257 mmt, of which 91 million is in the United States and 132 million is in South America. What that means is that the U.S. share of the world markets has dropped from 57% to 35%. In the case of beans, South America is the dominant force now in production whereas the United States has maintained a dominant position in corn, and wheat is a commodity that is grown in dozens of countries without one dominant producer.
As far as changing the business, grain companies involved in the cash physical side of the business focus their attention on basis trading. The further away geographically from the focal point for price discovery in the futures markets, which is Decatur, Ill. for soybean meal or the delivery points along the Mississippi River for soybeans then you get wider swings in terms of the basis levels. It is one of the reasons the Chicago Board of Trade launched a South American soybean contract, which has never developed much depth or liquidity. It becomes a trickier problem when most of your production is coming out of South America, and yet the futures market is based on a U.S. soybean contract. The other change from having the production migrate to South America is obviously that from an informational point of view there tends to be— even in the age of Internet — a little bit of a lag of information as to what is happening in South America vs. the ability of traders up here to stay on top of what is happening with the U.S. crop. It gives those of us who have some on-the-ground experience in South America a little bit of an edge in terms of analyzing the market.
In the case of soybeans, growing weather in South America is more important than the weather up here. With 35% of world production, and a big share of the export business to China coming from the U.S., I don’t want to minimize the importance of the U.S. but it is certainly not the dominant player [it was] when I broke into the business. Before the U.S. soybean export embargo in 1972-3 there was virtually no soybean production in South America. That embargo created a huge incentive for investment in Brazil and then Argentina was stimulated by Japanese trading houses [that] were victimized by that embargo. Given the importance in the food chain of soybean production they wanted an alternative to the United States given that we violated contract sanctity by slapping an embargo on exports at that time.
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.
FM: Do you think that they should be reined in? How?
Haar: Absolutely. I don’t expect that to happen in a big way because there are too many interested parties for whom these products are profitable and would probably succeed in avoiding any draconian restrictions. I suspect that unless there are interventions from the government or the exchanges themselves what will happen over time is that due to poor returns investors will lose interest in these products.
FM: These products have become popular because many people anticipated a long-term commodity bull market and the possibility of a hyper inflationary cycle.
Haar: I am not sure how effective they are going to be in performing that function and there are a lot instruments out there. That is the role of gold. There are TIPS (Treasury inflation protected securities). There are a number of different ways that one can make an inflation bet without owning the wheat market or the corn market, which are basically in a carrying charge structure that unless you get the timing perfect, are going to cost you anywhere from 5% to 20% a year, in the case of sugar, in carrying charges where you need to make that just to break even.
FM: We know that these products affect price in the short-term and that they change some spread relationships but what is your opinion on how they have affected price in the long term?
Haar: They certainly avoided the kinds of issues that would have come about if they participated in the spot positions or tried to create some sort of corner by buying physicals as well as the futures. Most of the impact has been on spread but there has been, in addition to the short-term volatility, some decline in the correlation between cash and futures. [This] has affected basis trading, with wheat being the most egregious case where they have come close to destroying the Chicago wheat contract as an effective hedging tool.
FM: How is this different than the commercial side exerting its influence over the market in the past?
Haar: There have always been imperfections in the system having to do with the nature of the delivery mechanism. The fact that some of the largest hedgers controlled some of the key delivery points created price distortions. There is no doubt about that. But to have a situation where at times in the past year the cash wheat market was $1 to $2 under the futures market in my experience is unprecedented.
FM: What is your opinion on some of the regulatory efforts that would make it more difficult for these funds to operate?
Haar: The clearest thing would be to just not give a hedge exemption to any entity other than a commercial buyer or seller of the underlying physical commodity that is in the business of dealing with the commodity subject to these restrictions. The futures markets can’t function under the idea that they are serving as an inflation hedge to investors. Again, there are other products that can serve that function. The gold market [is one]. There are index contracts like Goldman Sachs futures or Dow Jones UBS futures but the problem is there isn’t enough liquidity for those people to participate. So they are using other futures markets for individual commodities as a surrogate to put together the index. I don’t think that the market [can] handle it.
In the case of soybeans, index funds are long at the moment 175,000 contracts. That is 875 billion bushels, which is roughly five or six times the size of the carryout this year. In the case of wheat, it is even more ridiculous. There [are] basically 1.125 billion bushels of index fund positions which is more than the carryout for wheat this year and soft red wheat production this year is only 404 million bushels, which is the specific contract specs for the Chicago contract, so you have almost 3 times index fund positions than the size of the whole crop. I don’t see how the markets can function effectively with that kind of distorted participation.FM: Talk a little bit about your trading philosophy.
Haar: My philosophy, which I learned from making losing trades, is to stay humble, recognizing that I don’t really know which direction the markets are going to take, no one does. What I try to focus on is assessing the probabilities of different scenarios occurring and try to filter through existing situations to find risk/reward opportunities that look attractive. As a result of that process because of all the unknown factors for any commodity, in my opinion, the proper position as a speculator to have most of the time in most markets is no position. It is only when you reach a certain situation where analyzing the supply/demand situation, analyzing trends in climate, analyzing the political situation and the direction that those variables are likely to find situations where it seems as if there is a 50/50 chance of the market going down 5% or up 10-15%, if a certain event occurs. If you can asses those probabilities correctly, then those are bets you should place and ultimately over time you will do well not really ever knowing because of the 50/50 nature, exactly what the market is going to do. On top of that is experience with money management, position sizing and risk control.
FM: How did your philosophy change from hedging cash risk to trading for investors?
Haar: In some respects the speculative side is easier. You have the luxury of picking and choosing the points when you want to participate in the markets. If you are a soybean processor, you have to come in every day and have some sort of approach to not only the futures price in Chicago but also the cash basis levels, transportation risk and currency risk. You also have to stay on top of customer risk in terms of credit. It is a much more complex situation with many more variables. Now I am only focused on the flat price or the relative value between the different futures contracts I trade.
Also, what I have always enjoyed in my life is looking at economic and political analysis as well as incorporating that into the approach to the futures market has become increasingly important in recent years. After the economic meltdown suffered in a global basis in ’08 which we are in the process of emerging from , or not, it is clear that the macro economic variables have become as important or in the short term more important in their effect on market prices than the traditional narrowly focused supply/demand factors for any given commodity. That has made the speculative side more challenging. As a result, I have decreased the size of the positions and numbers of positions because what has occurred over the last couple of years where macro drivers have been affecting all markets is that the correlation between the movement among commodities has increased dramatically where on most given days 80 or 90% of them are going up or down on the same day.
FM: The growth of commodity funds occurred right as your CTA was launching. How has it affected your trading?
Haar: It has been one factor that has resulted in poorer performance over the last two years vs. the trading prior to that. It has complicated things in term of adjusting to that. I adjusted in 2007 by reducing risk and the number of positions because they were trading in a correlated fashion. It has made things more difficult. It is hard to separate the impact of the index funds from the fact that the real world macro economic environment has become much more unstable over the last few years. There is a fundamental linkage behind the kind of uncertainty we have in the economic environment and how it is reflected in the futures prices. Generally over the years, the focus on anyone trying to analyze what direction futures markets were going to take, particularly on the ag side, were generally focused much more on the supply side. Almost all the attention was on the supply side because it was supply shocks often times created by weather anomalies that would drive the large changes in prices and the demand side was largely taken pretty much as a constant. The consumption side would grow by a couple of percentage points a years based on population growth plus small incremental increases in disposable income that would flow through to the food basket. The kind of economic environment we have been living through for the last couple of years has created a big question mark on the demand side because the depth of the recession we just came through, and the possibility of additional economic turmoil in Southern Europe that is going to have an impact on consumption, particularly the more discretionary food items like coffee and cocoa, so that has become an additional complication in analyzing the markers.
FM: Have you attempted — as other have — to exploit some of the transparency of money flow due to the funds or are you simply trying to avoid getting slapped around by them?
Haar: No. From what I have seen observing the market over the last few years, any type of opportunities to gain from that has pretty much filtered away. The managers of those types of instruments have become more prudent in how they manage those types of flows and rollovers.
FM: Let’s talk a little about the fundamentals of the grain complex. After a crazy year in 2008, they have been somewhat quiet. What main fundamental factors are you looking at?
Haar: We are back to looking at the traditional factors on the supply side, which are largely weather related. The markets have gone back in the last year to a somewhat more typical quiet period, where in the absence of supply shocks the markets tend to trade in a narrow range. It is somewhat of a return to normalcy. The reason for that is, at the moment, there is nothing that is in short supply. The markets are pretty much well supplied with in the case of soybeans and wheat record levels of carryout stock thanks to the fact that we just came through a very benign weather season in South America, which generated record size crops in Brazil and the fact that last year [we] wound up with near record yields in production here as well. At this point we are off to the best start in my 30 plus years being around the ag markets. Farmers are ecstatic. They have had a record pace of early planting, which are generally favorable for yields. Unless there is a change in weather patterns as we get into the more critical growing months of July and August, we could be faced with an additional supply build going into next year, even penciling in robust demand for China.
One of the things we are looking at is some early projections of the return of La Nina later this year into the following year, which if it occurs soon enough could clip some of the production potential off of the U.S. crop but more importantly would have some negative consequences in South America for their next bean crop but that is months away and we don’t know if and when that becomes a factor but it will be something I will be watching and other traders who trade off of the fundamentals will be looking at.
FM: What is your outlook for the 2010 growing season for: Corn, wheat, soybeans?
Haar: Right now given that they are off to a great start and that we have rebuilt some of the stock, particularly with beans, that were in existence a year in a half ago, in the absence of below trend yield, the fundamental trend in the market should be to drift lower. It is difficult to come up with a fundamental scenario where you don’t have an additional build in carryout in soybeans, possibly corn as well, wheat will probably stay the same but it is already near record levels on a worldwide basis. Under that scenario, higher prices will have to come from increased investor demand or heightened concern about inflation or a sharp decline in the dollar. Those could be macro factors that short circuit the fundamental tendencies in the market that point to lower prices.
I am not sure if we are going to see prices [in the $5 area for beans and $2 level for corn] partly because of the permanent layering in of the index funds providing a floor to the prices, and also the fact that you have some improvement on the demand side due to the growth of consumption in China and other developing countries that will probably continue. At these prices, the farmer is going to be making money both in corn and soybeans. Plus people ignore the huge increase in yields over the decades. A lot of that is attributable to breakthroughs on the genetic side. The year to year average gain in productivity has been accelerating in the last few years. Don’t underestimate the ability to gain on the production side without ripping up new land in the Amazon jungle or deforesting parts of the United States. There is a continual improvement in yield due to science and technology.
You asked about the impact of having an increase in production in South America. One thing that does for you is you basically have two production cycles a year rather than one. Therefore if you had a problem in the U.S., or if you had a problem in South America in any given year resulting in a boost to prices that would immediately send a signal to the other hemisphere to ramp up their production so you don’t have to wait a full year to get the production increase. You are basically more on a six-month cycle. On an inflation-adjusted basis it is highly unlikely that you would see the kind of prices we saw in 1972-73 when we came a shade from hitting $13 per bushel, today that would be around $30. For that to happen, you would probably need to have back to back major crop failures in both hemispheres to start thinking about prices getting that high.