From the November 01, 2010 issue of Futures Magazine • Subscribe!

Kottke: A lifetime in grain markets

imageFM: There are many people, particularly in Congress, that believe these funds have had a dramatic influence, particularly in crude oil. What is your opinion on that?

NK: I would disagree. Congress has alleged that the funds caused the energy spike. The world uses 80 million barrels of oil a day, prices 80 million barrels a day. When you compare that to the amount of speculative capital that is available for crude oil trading, it is ridiculously small. You are talking about a massive markets and the cash was trading there. They didn’t make that up. Now there are a lot of influences. China is increasing demand and adjustments had to be made by other users and producers. That is what makes these markets, it isn’t money running on the screen that makes the markets. These people are over impressed with what they think they see, they are seeing the tip of the iceberg. It is ludicrous to think that capital in the futures markets was driving the cash crude oil market. They are looking for a villain and the villain is the world, but that is not a popular thing to say.

FM: What about wheat?

NK: The long-only holders of soft red wheat in Chicago have impacted the delivery mechanism or the spread, but even there I would submit that the issue with wheat spreads and delivery is not the long-only funds, the issue is with the soft red wheat contract itself and what is deliverable. It is a small contract and being made more difficult by the delivery specifications.

FM: Can you trade commodities without taking into account the effect of long-only funds?

NK: If you trade commodities, you have to take into account every factor that you can. So long-only is a factor, but it is an overrated factor. One of the things that a very wise trader told me was a comment made during a market rally [when] somebody said, ‘Well I don’t like the quality of the buying,’ and this person said, ‘Sir, I would suggest to you that you don’t look at who you think is buying or selling the market, you simply look at where the market is itself.’ And I agree with that.

FM: The Commodity Futures Trading Commission (CFTC) is mandated by Dodd-Frank to create a spec limit regime that encompasses both futures and over-the-counter (OTC) markets. Are you expecting significant changes as it pertains to grain markets? What do you think will be the impact of aggregate position limits?

NK: I presume that there will be a hedge exemption and from that presumption it will become quite difficult to discern that which is a hedge and that which is not when you talk about over-the-counter markets or cash markets. Specifically when one talks about grains. It could be done in Bermuda. The market will adjust. [Regulations] can be as tough as they want, but there will be those in Geneva, Switzerland who will trade cash grain if they wish. This is not unprecedented. Back in the 1970s there was a cash grain market. We called it the Italian corn market, and the trading unit was 1 million bushels of corn, and it traded. Sometimes it was delivered and sometimes it wasn’t but it was a real market. Now who is to say that is not a hedge or that it is a hedge. I can assure you that anyone who was a commercial just took it into their position and treated it as their overall position. My point is that you can create a cash market and it can be real. The results of that market are part of the world market which is reflected in positions and valued on the CBOT. It is an international market particularly in grains.

[Regulators] can only influence those that are captive—that is U.S. citizens, U.S. companies and or those that elect to — otherwise they will be ignored.

FM: Do you think the CFTC realizes that?

NK: I don’t know what they realize. An amazing thing that I have observed over time is that those that wish to legislate behavior are victim to the wish becoming father to the thought: if I wish to do this, then I think I can. There is no monopoly on these markets and I believe the open interest in [European] wheat is now exceeding ours.

The notion of legislative limits is always food for thought. We have limits on price and today is a perfect example (we spoke to Neal on Oct. 8 when the grain complex was locked limit up after the United States Department of Agriculture world supply/demand report). December corn is limit up 30¢ higher. We have ordained that. Therefore it is $5.28 ¼. The fact is even on our own exchange, synthetic futures options are trading 36¢ higher. Now you tell me what the limit is. So the market is working in spite of 20 feet away an options market trading 36¢ higher.

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