William (Bill) Plummer has spent more than 40 years in the futures industry. It was an edge he saw in the egg market that first drew him to the futures markets in the 1960s as an egg price analyst. He has been trading ever since.
Plummer worked in various brokerage positions throughout the 1970s and was a member of the Chicago Mercantile Exchange where he served on numerous committees. He was responsible for developing the commercial futures business for Drexel Burnham Lambert in the 1980s and directed its livestock trading group. He traded the proprietary livestock portfolio and developed hedging models for its institutional clients.
In 1990 he formed Frontier Risk Management, LLC, an introducing broker that advises institutional livestock concerns in building complex hedging strategies.
In 1991 he launched Range Wise, a fundamental discretionary commodity trading advisor (CTA) that trades livestock spreads and grain options. Range Wise has produced a compound annual return of 11.33% over its 20-plus years. Plummer has a unique view of markets, as well as a unique taste in art, as American contemporary art is a passion. He lives primarily in Aspen, Co., but we sat down with him in his Chicago office to talk about the fundamentals of ag markets and how they are changing.
Bill Plummer: There has been. The biggest fundamental change in my mind is [that] of the rate of growth in demand worldwide. World supply has grown on a more or less regular basis over the past 40-50 years. The factors that have contributed have been improvement in farming techniques, improvements in genetic seed stock; the yields have improved on a more or less regular basis. That has been one constant, an increasing level of available supply. Increase in acreage (particularly) in South America and, with the fall of the Soviet Union in 1989, vast amounts of land becoming available to more efficient farming techniques, are some of a variety of factors [that have] allowed the supply to grow.
We have had demand generally rising in a pattern that has been consistent with the growth of supply. The driving factors in demand are: General population growth, improving incomes around the world, starting with the fall of the Soviet Union. Prior, demand was driven by population growth. After the fall of the Soviet Union the vast areas that had been under the rule of centrally directly statist’s economies opened up. With that, there were improving income levels. From a demand standpoint the big event that took place was the Chinese government allowing a quasi-capitalist form of economics. That set off a revolution in China that took the most populous nation on earth from abject poverty to a [higher] standard of living. This revolution not only occurred in China but in India and parts of South America. So you had a revolution in terms of growth in personal income of vast [numbers of] individual human beings. The first thing that happens when a population comes from poverty/subsistence living and starts to gain disposable income is [people] move from a vegetable-based diet to an animal- or protein-based diet, [which] calls for more grain to be fed to more animals, which leads to more demand for grain. This began in the early 90s, [accelerated] in the 2000s and continues today.
With these two trends overlaying each other we would go through price advances that would be governed by weather; a crop failure would [occur] and we would have a spike up in prices. The spike in prices would cause more land to come into production and we would accumulate.
In 2003 the ethanol industry really got its legs under it. With government subsidies [and] a government mandate to blend a certain amount of corn ethanol with gasoline, the ethanol industry began to grow.
At one point the ethanol industry in 2003-04 consumed about 7% of the U.S. corn supply, and then 10% and then 15%. Today the ethanol industry consumes a little more than 35% of the total U.S. corn supply and next year it is forecast to consume as much as 40%.
Overlay food-based demand vs. world supply and add this dramatic increase [because of] ethanol, and all of a sudden you have a situation where the balance between supply and demand became precariously narrow. What separates this period that we are in now and the last 30 years is that [with] the rate of growth of ethanol and population, we are not going to be able to build the kind of huge stocks we previously were able to without taking prices to another level. That is the fundamental change. We have taken prices higher; the question is, ‘ have we taken them high enough?’ We don’t know the answer to that yet.
We know that in order for the USDA [predictions of] a 675-million-bushel carryover this year for corn [to be true], we are going to have to reduce feed usage significantly in the last half of this year. I am not sure we are going to be able to do that. The only area we may cut demand is in exports. Some of our [anticipated] exports could be replaced by the terrible quality of the Australian wheat crop, but we don’t know if that is going to be done. The real wild card is China. China says that they have plenty of corn but one would ask ‘why has China been selling large quantities of corn out of their reserves and prices are still at all time record highs? Why have Chinese industrial plants that make things from corn been prohibited from buying corn from farmers directly?’ If China comes into the marketplace, then that is a whole new ballgame, and we will take prices much higher. China is going to come into the game [as] an importer. The question is going to be, ‘are they going to import more this summer when our supplies are potentially tight or are they going to wait until we have our harvest and buy from next year’s crop?’ That is just kicking the can down the road. If they don’t buy it this year that means that we don’t get $9 corn this summer; we will just get it next year.
FM: As a fundamental trader, how do you react to the long-only indexes? Do you view them as a fundamental element that needs to be followed?
BP: The indexes certainly have a short-term impact on prices at the beginning of every month when new money comes into the market. If there are positive money flows, [we] are going to have price advances that may last two or three days. If there are negative flows, [we] are going to have a price break that is going to affect the market in the short-term, but on a longer-term aggregate basis I don’t think they really mean anything in terms of what the overall price is going to be. Yes, maybe they are responsible for some buoyancy in price but I wouldn’t call it dramatic. The fundamentals ultimately set the price. What is the supply/demand balance, how much of any given commodity is left over at the end of the production year? That [is what] affects price. Money flows from the long-only funds and from hedge funds and the entire speculative community for that matter, have increased the volatility in the marketplace, but I don’t believe [they have] increased the overall price level of any of these commodities.
Volatility is caused more by managed futures and by hedge funds than by the long-only funds. The long-only funds will affect activity around the end of the month and when they do their rolls; they are a fundamental. They definitely affect the market during the rolls.
I am aware of the roll. There are times when it is a good idea to be involved in the roll — selling the front, buying the back — if you are near carry it is stupid to do it but if there is a big premium of the near buy then it is a smart thing to do. There are guys who make a living in livestock with it. It is a great way to add a little bit of profit to your portfolio. The grain markets in times of tight supply can be dangerous. The best thing is to just not to be putting new positions on during the roll period. In my case I avoid adding to positions when I know the roll is coming. I might lighten up ahead of the roll but I don’t objectively trade the roll in near carry markets. They are a fundamental.
FM: Do you think there needs to be a regulatory remedy or do they simply represent another fundamental factor that needs to be worked into a trader’s analysis?
BP: No. First of all, is there such a thing as a regulatory remedy? There are laws on the books and [with] every new regulation that comes out of Washington you have the law of unintended consequences. No human being can anticipate how the market is going to adapt to any new rule. The best thing to do is let the market solve the problem.
FM: What about position limits?
BP: The market will go elsewhere. This is a world market, crude oil especially. Right now this call for investigation of speculators by the president is just a political ploy to divert public attention from his disastrous policy of pushing for alternative fuels and banning of offshore drilling.
FM: Technical traders acknowledge that systems need to be updated. Do fundamentals change, or perhaps do new fundamentals emerge that must be considered?
BP: Ethanol is a huge new fundamental factor. You have to be aware of changes in production capability and you have to be aware of changes in demand structure for any one of these commodities. In terms of supply, you have to be aware of advances in growing techniques, but these are broad based and they don’t make a difference in the short-term. But a new fundamental such as the use of ethanol is extremely important.
FM: One of Range Wise’s Strategy Objectives is global adaptability. Explain what you mean by that and provide some examples of how you have “adjusted to new factors that influence commodity prices and removed old factors.”
BP: Global adaptability is just recognition of what is changing in the world. For instance, the turmoil in the Middle East definitely has caused an increase in wheat demand because one of the ways the old regimes are hoping to placate the demand of their people for change is by giving them more food, food subsidies, [etc.], so there has been a definite increase in food wheat exports to those nations. That is an immediate example. The tsunami in Japan [is another]. The markets actually misinterpreted what it meant. The market had a dramatic break two days following the tsunami. What I think really happened is that it allowed users of soybeans and corn who did not have forward coverage to put that coverage on and insulate them from upward price movement during this coming summer. It basically had the impact of reducing the likelihood of price rationing to occur gradually. Users who didn’t have forward coverage were able to get coverage at prices where they didn’t expect to get covered. That means that operating for them will continue to be profitable far longer than it would have been. They locked in their profit margins for a longer period of time than they likely would have been able to. That means more usage.
FM: Describe the different approach to the markets when hedging and operating a CTA.
BP: At various times [companies that I run] have developed strategies that guide hedgers. Anybody that is a real hedger, a real producer of a product, has to have a [very] bright line between genuine hedging activity — using futures as a tool to lock in margin on production—[and speculating]. Now I may have an opinion on the market and want to take advantage of it because I know something now. That is speculation and that is over here. If you are in the business of making something, you have to keep the hedging activity on one side and the speculative activity on the other.
FM: Talk a little bit about the food vs. fuel debate. Is this a driving factor in agricultural markets?
BP: The fact of using biomass for fuel plus the growth of demand coming out of China and other places are the primary factors in ag markets right now.
FM: How big of a factor has the weak dollar been on commodity markets?
BP: We price our commodities in dollars; people [who] buy our commodities price them in their local currencies. So if our dollar is weak relative to their local currency, they are going to be able to buy more of our things at what to them is a relatively stable price level. A weak dollar always will put upward pressure on prices. And if we get into an inflationary environment, which we could [be headed into], then the dollar will get weaker and our commodities will go much higher than they currently are today.
FM: Are these the real factors behind rising prices?
BP: I would say the growth of demand for food because of the improving incomes [of] the Asian nations and to a lesser extent Brazil, is one big factor. The other big factors are the growth of the biomass fuel industry that is using agricultural products that traditionally have been used to feed people, and the dollar being so weak. A weak dollar makes it less expensive for a population of another nation to buy our commodities. Those three factors all are contributing to advancing prices in commodities.
FM: Why is it so easy for certain folks to ignore the obvious and just blame speculators?
BP: The politicians are looking for a scapegoat; the scapegoat is speculators. A little bit of self-examination on the part of politicians would be helpful. I don’t think that speculators are causing it but if the government adds additional regulations, all [it would] do is make the cost of doing business more expensive. If the cost of doing business is more expensive then there is less profitability, and ultimately you get less of the end material that you need. The way to deal with price advances is to increase supply; demand will be rationed by advancing price. The markets are going to go where they are going to go, to the extent that government interferes with the market activity it creates a problem. If the market has a year or so to adjust to a developing situation then it will do it in a gradual fashion; if the market doesn’t have the time to adjust then it is going to be much more painful. Regulation often has had the unintended consequence of causing activities to occur that the regulation is designed to prevent. It is a populist political argument. It is easy for a politician to blame whatever bad thing is happening on the capitalist system as opposed to looking at the government.
FM: Where do you see the dollar going?
BP: In the short-term the dollar probably is going to get weaker. It is going to get weaker until the Federal Reserve starts to raise interest rates. The chairman of the Federal Reserve has said he doesn’t see interest rates going up any time soon here in the United States. We know interest rates are going up in some of the other currencies so it is really a question of mathematics. Where you get your best return? I do see a dollar that is going to be weak for an extended period of time. We have many political issues that have to be dealt with. If our budget deficits are going to stop at some point and if we are able to pay down the massive debt or stop accumulating more of it then we would see strength in the dollar.
FM: There are more technical systematic speculators in the agricultural markets than fundamental traders. Does this give you an edge?
BP: I believe it does give me an edge. Having an understanding of where prices eventually have to go in order to resolve the supply/demand equilibrium equation gives you a distinct edge. If you are a technical operator [and] the market is going down, you assume [it] is going to keep going down until it turns around. If it penetrates certain chart points it is a signal for you to liquidate your position or add to [it]. If you are a momentum trader and the market breaks out in one way or the other you add to the position. Technical analysis is an important tool for me and I certainly don’t dismiss its validity. Where I have an edge is the fundamentals tell me when the technicals are likely giving a false indication of what the ultimate direction [of] the market is going to be. Where they help is, the market often follows a convoluted path to get to its ultimate objective and gives many false signals, so avoiding losses during those time periods is very helpful. Technical indicators can do that for me.
I can wait on my view; I can take short-term advantage of it. Having an understanding of the fundamentals, even the micro day- to-day fundamentals, you can see short-term fundamental factors that you know the overall marketplace is going to interpret as being either positive or negative. You can position yourself based on your advance knowledge of how the fundamental factor is likely to be interpreted by someone who is not deeply immersed in the long-term fundamentals.
FM: You utilize options in a unique way. Explain how you trade options and what edge it gives your program?
BP: I establish positions in options that are directional in nature and allow me to position myself in advance of what a move will be. I can start out with a relatively small delta position but if my options position has a positive gamma component, as prices either advance or decline my positions on a delta basis get bigger and bigger and bigger. It is a low- risk way of entering the market. By rolling my positions up or down I may able to capture profits on a continuous basis. If I should be wrong the market, the way I construct my positions, [they] naturally reduce themselves during adverse price movements. If I maintain a fundamental opinion that I will eventually be correct in my judgment on the market, I am able to reinstate that position at lower price levels. Options allow me, if I am correct in my fundamental judgments, to enter the markets with minimal risk and capture outsized returns or in the converse, if I am wrong the market, I get taken out of the market naturally without having to wake up in the morning and be trying to sell out my positions. I can go to sleep at night knowing that adverse price movement [will] take me out of the market.
If the market goes in the direction that I think it is going to go, then the size of my position generally will be increasing. If it goes against the [direction] that I think it fundamentally should go, my position generally is decreasing. If I am absolutely wrong it turns into a position opposite to the one I held and will increase as it goes down. There is a lot of comfort trading that way.
FM: You have been involved in grain and livestock markets for more than 40 years. Give us your medium- to long-term outlook for both sectors.
BP: Starting with livestock, right now we are likely to have a wash out in prices, especially in the cattle market this summer. The worst of it is going to occur in late July/ early August because we have a lot of cattle on feed right now and prices are high. After that we will have worked through the large supply that we have, the quantity of animals available to feedlots is going to be diminished so that 2012 will be a year of advancing prices. Down now and then up. As corn prices [rise] that actually will force animals to market sooner because [producers] have to feed corn to animals. If corn prices are very high they will bring the animals to market more quickly and that will temporarily depress prices.
In the case of grains, there is a real chance, especially in corn, of record price levels some time this summer. Unless the government reports are misleading us, we will go to record prices this summer. That will cause a reduction in demand and in a normal cycle we would have prices break into the fall, depending on how the crop is. I can say quite comfortably that the growing season has not gotten off to a good start. It is not too late to have a good crop but with each passing week that we are not getting the crop into the ground, the odds diminish.
If we have a perfect summer, we can have really good yields and that would push prices down but at the same time we still have this world demand engine that keeps growing. I don’t think we will be able to build the kind of surpluses that will hold prices down for three or four years at a time as they have in the past.
On the other hand, if we have a poor growing season this year, then all bets are off as to where prices are going. We just won’t have enough of the stuff.