Speculating and Hedging: Two Sides Of Your Coin

July 28, 2017 09:38 AM
Speculating and Hedging: Two Sides Of Your Coin

The following guest article is by Joe Lardy, CHS Hedging Research Analyst.

Some producers and consumers consider market speculators as middlemen who offer little value while reaping plenty of monetary rewards. However, speculators add significant liquidity to the marketplace which allows producers and companies to hedge against weather, yields and dramatic price changes. Sure, they earn a profit if they do their jobs well. But they also assume great risks to maintain greater stability for producers and consumers.

With the help of technology to manage complex algorithms, the art of speculation –making high-risk investments in hopes of getting a huge return— has become much more individualized and more specialized.  Speculators are laser focused on market price changes in stocks, property, or other ventures to make a profit. Like all modern-day speculators, those specializing in agricultural commodities make their buying and selling decisions based on the price at which they believe a commodity will be trading at some point in the future, whether that means tomorrow or a year from now.

If speculators know one thing for certain, it’s that the futures market is guaranteed to fluctuate. And they also know that with those fluctuations comes the opportunity for greater profit. Risk-takers by nature, speculators have the ability to act faster during times of great fluctuation in order to maximize their payout.

Speculators typically take the form of hedge funds, investment funds, or commodity trading advisors (CTAs) that manage the assets. Almost every commodity-trading fund utilizes an algorithmic trading system, also known as a black box. The black box is a computer-driven model that can analyze enormous amounts of data and make millions of complex calculations in a split second. A black box hedge fund is preprogrammed to identify and exploit any perceived weakness in the market. It can place thousands of orders per second if programmed to do so. It is also important to note that most funds do not consider fundamentals such as weather, crop conditions, and planting dates like those connected to the physical world of commodities.

So you’re probably asking yourself how a speculative fund’s computer program that buys or sells corn impacts you. The fact that these funds have significant influence on the futures markets, and that influence continues to grow at an expedited rate, means they will control more and more assets, and have an even greater influence on the futures markets.

According to investment bank Barclays, the total assets under management in commodities funds grew to $220 billion in 2016. As represented in the chart, the number of futures contracts held by the funds impacts the price of corn. When the funds make big corn buying or selling moves, as indicated by the blue line in the chart, there is a corresponding change in corn price, shown in red. If you see the funds on a sustained buying pattern, it is a pretty sure bet that price is going to rise.


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