New Threat to Farmers: The Market Hedge
Fred Grieder, a farmer near Bloomington, Ill., has more to worry about these days than hard work, crops and rain. If the market for commodities futures turns the wrong way, he could be wiped out.
Fred Grieder has been farming for 30 years on 1,500 acres near Bloomington, in central Illinois. That has meant 30 years of long days plowing, planting, fertilizing, and hoping that nothing happens to damage his crop.
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Previous Articles in the Series »"It can be 12 hours or 20 hours, depending," Mr. Grieder said.
But Mr. Grieder's days on the farm in Carlock, Ill., are getting even longer. He now has to keep a closer eye on the derivatives markets in Chicago, trying to hedge his risks so that he knows how much he will be paid in the future for crops he is planting now. And the financial tools he uses to make such bets are getting more expensive and less reliable.
In what little free time he has, Mr. Grieder attends Illinois Farm Bureau meetings to join other frustrated farmers who are lobbying officials in Chicago and Washington to fix a system that was designed half a century ago to reduce uncertainty for food producers but is now increasing it.
Mr. Grieder, 49, is shy about complaining amid so much prosperity. Prices for his crops are soaring on the updraft of growing worldwide demand, and a weak dollar is making those crops more competitive in global markets.
But today's crop prices are not just much higher, they also are much more volatile. For example, a widely used measure of volatility showed that traders in March expected wheat prices to swing up or down by more than 72 percent in the coming year, three times the average volatility for that month and the highest level since at least 1980. The price swing expected in March for soybeans was three times its monthly average, and the expected volatility in corn prices was twice its monthly average.
Those wild swings in expected prices are damaging the mechanisms — like futures contracts and options — that in the past have cushioned the jolts of farming, turning already-busy farmers into reluctant day-traders and part-time lobbyists.
One measure of the farming industry's frustration is the overflow crowd expected at apublic forum on Tuesday at the Commodity Futures Trading Commission in Washington. Interest is so high that the commission, for the first time ever, will provide a Webcast of the forum, which it says is being held to gather information about whether key markets for hedging the price of crops "are properly performing their risk management and price discovery roles." The Webcast link is available on the commission's Web site, www.cftc.gov.
The additional costs that stem from volatility in grain prices — higher crop insurance premiums, for example — are not just a problem for farmers. "Eventually, those costs are going to come out of the pockets of the American consumer," said William P. Jackson, general manager of AGRIServices, a grain-elevator complex on the Missouri River.
Prices of broad commodity indexes have climbed as much as 40 percent in the last year and grain prices have gained even more — about 65 percent for corn, 91 percent for soybeans and more than 100 percent for some types of wheat. This price boom has attracted a torrent of new investment from Wall Street, estimated to be as much as $300 billion.
Whether new investors are causing the market's problems or keeping them from getting worse is in dispute. But there is no question that the grain markets are now experiencing levels of volatility that are running well above the average levels over the last quarter-century.
Mr. Grieder's crop insurance premiums rise with the volatility. So does the cost of trading in options, which is the financial tool he has used to hedge against falling prices. Some grain elevators are coping with the volatility and hedging problems by refusing to buy crops in advance, foreclosing the most common way farmers lock in prices.
"The system is really beginning to break down," Mr. Grieder said. "When you see elevators start pulling their bids for your crop, that tells me we've got a real problem."
Until recently, that system had worked well for generations. Since 1959, grain producers have been able to hedge the price of their wheat, corn and soybean crops on the Chicago Board of Trade through the use of futures contracts, which are agreements to buy or sell a specific amount of a commodity for a fixed price on some future date.
More recently, the exchange has offered another tool: options on those futures contracts, which allow option holders to carry out the futures trade, but do not require that they do so. Trading in options is not as effective a hedge, farmers say, but it does not require them to put up as much cash as required to trade futures.
These tools have long provided a way to lock in the price of a crop as it is planted, eliminating the risk that prices will drop before it is harvested. With these hedging tools, grain elevators could afford to buy crops from farmers in advance, sometimes a year or more before the harvest.
But that was yesterday. It simply is not working that way today.
Futures, for example, are less reliable. They work as a hedge only if they fall due at a price that roughly matches prices in the cash market, where the grain is actually sold. Increasingly — for disputed reasons — grain futures are expiring at prices well above the cash-market price.
When that happens, farmers or elevator owners wind up owing more on their futures hedge than the crops are worth in the cash market. Such anomalies create uncertainty about which price accurately reflects supply and demand — a critical issue, since the C.B.O.T. futures price is the benchmark for grain prices around the world.
"I can't honestly sit here and tell you who is determining the price of grain," said Christopher Hausman, a farmer in Pesotum, Ill. "I've lost confidence in the Chicago Board of Trade."
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Rodrigo González Fernández
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