From the June 01, 2011 issue of Futures Magazine • Subscribe!

Grain trading basics

While grains have been traded as long as they have been grown, the modern grain futures contract has been around for about 150 years. In that relatively short time, grain futures trading has grown and evolved from a domestic weather and supply driven market to one driven by global macroeconomics and production.

While financial contracts have become the most heavily traded futures contracts by volume, grains still are what many people think of when considering trading futures. Jokes abound about traders being worried they will end up with a truckload of corn on their front lawn. Grains hold a special spot, and understanding the factors unique to this market ultimately leads to success.

As in all markets, supply and demand are the primary drivers, but those can be affected by weather conditions, emerging markets, crop conditions and even exchange rules.

Weather

Weather always has been a major factor in grain trading because it affects everything from planting, to crop condition, to harvest, to yield. This is distinctly different from other markets like financials and metals in which weather has a marginal impact.

For grain traders, though, weather forecasts give a glimpse into what may happen to the supply of grains come harvest time. Experience teaches us, however, that forecasters hardly are infallible. "When you look at five different weather forecasts, you’re probably going to get five different opinions. You’re not looking for them all to agree with one another, you’re looking at how the forecasts are changing," says Helen Pound, senior market analyst at Penson Futures.

To that end, she says to focus on changes in weather trends and don’t stick to just what one forecaster says. "You’re not looking for which weather forecaster is the truest or most accurate, you’re looking for a general sense of how the weather forecast is changing," she says.

Also, weather impact varies based on other factors, both environmental and more traditional. Soil moisture levels are a key factor. A crop will withstand drought conditions longer if there is adequate moisture going into the growing season. Groups such as the European Space Agency (ESA) use satellite imagery to provide evidence of soil moisture for the United States Deparment of Agriculture (USDA) and people in the trade to help in hedging their production.

Strong inventories from the previous growing season — or carryover — will dampen the affect of adverse weather, whereas low carryover from the previous year will make the market more sensitive to anything that can affect yield.

Like most of the modern world, grains have taken on a global scope with multiple growing seasons around the globe. Consequently, traders also need to be aware of weather patterns and soil moisture levels around the world to fully grasp how the supply picture changes. "With South America becoming such a major soybean and corn producer, traders not only have to watch what is happening here in the spring and summer, but also what is happening there in the fall and winter (their growing season)," says Mike Zarembski, senior commodity analyst at optionsXpress.

Extreme weather problems in any part of the world can have a dramatic effect on grain prices. Just last year, Russia and Eastern Europe experienced severe drought conditions that resulted in Russia stockpiling and not exporting any of its wheat crop. The result was a run-up in the price of wheat futures traded at CME Group (see "Scorched earth"). "Traders need to know what is produced in each region of the world; Russia was big with wheat last year. Because this is a global grain market, if one area is having difficulties, it could spur price increases in another area as they take over some of that business," Zarembski says.

Also, changes in price can affect planting intentions. If a farmer can make more profit in corn than soybeans, he will plant more corn and this will eventually play out in price.

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