Fixing what's wrong with the live cattle futures market isn't rocket science; it's more like brain surgery.
Fixing what’s wrong with the live cattle futures market isn’t rocket science; it’s more like brain surgery.
Cattlemen from around the country discussed the intricacies of modern commodity futures trading during a standing-room-only meeting of the National Cattlemen’s Beef Association live cattle marketing and international trade committee at the group’s summer conference last week in downtown Denver.
For the last six months, members of a special NCBA working group, together with the national officer team, have tried to determine what can be done to reduce market volatility.
“This volatility, whether you are a speculator or a producer, is too much to swallow,” said Jordan Levi, a cattle feeder from Oklahoma City, during the meeting.
Proposing changes to the complex mechanisms of the market, however, requires delicate maneuvering on the part of both cattlemen and Chicago Mercantile Exchange officials.
Another way to look at it is kind of like a game of chess.
“You move something here, and it moves something over there,” described Shelby Horn, president of Great Plains Cattle Feeders of Hereford, Texas, who is part of the working group.
Although there were differing views on how futures contracts should be revised and updated, at least one clear consensus has already emerged.
“It appears to me that high frequency trading and today’s technological forces have moved beyond and overshadowed the market, and that has to be a concern,” summarized T. Wright Dickinson, of Maybell, a past president of the Colorado Cattlemen’s Association and a voting delegate at the meeting.
Many cattlemen, Dickinson included, hypothesize that hyper-fast, automated trades are responsible for an increasingly erratic market that has made taking positions untenable for cattle hedgers and even traditional speculators.
Indeed, the speculators and mutual funds long considered by many cattle producers to be their nemesis are now starting to look quaint in comparison to an emerging breed of high-tech “momentum” traders that take bets solely on which direction the market will go.
“The high frequency traders are not the funds, although a lot of people want to confuse them,” said the committee’s chairman Ed Greiman, of Garner, Iowa, in an interview. “The funds are fundamental traders, and they hold onto their positions for long periods of time. They will hold them for weeks or months, whereas high frequency traders are just day traders. They hold their trades for seconds or minutes.”
Horn said the group wants better marketing data and analysis to evaluate the effect this newfangled trading activity is having.
“We think this is causing the market to move in big spurts,” he said.
Craig Uden, a farmer-feeder from Elwood, Nebraska, and president-elect of the organization, explained why the constant movement is so destructive.
“I lost $10,000 on my positions yesterday,” he explained in an interview. “Today, I got $8,000 of it back. In just the time we’ve been talking, the markets have gone down $2 a hundredweight. I’m trying to manage risk on my live cattle, but this totally drains your liquidity. The market is chasing out the producers with these volatile moves.”
During the meeting, Greiman said the working group was drafting a letter to the Commodity Futures Trading Commission demanding greater market transparency, specifically an in-depth analysis of all the trades made on a few high volume, highly volatile trading days last year.
They also plan to press their case with the leadership of the House and Senate ag committees following the Labor Day recess.
For privacy and confidentiality reasons, the CME has refused to review an audit trail of trading activity, and it’s not clear whether the CFTC will be willing to do it either.
“If not the CFTC, then I have to ask who? We need some oversight,” Greiman said in the interview.
“We have heard that after we visited with the CFTC commissioners, they did go to the CME and asked for some information,” he continued. “So this shows that they must not look at this information all the time. We will be asking them what information they’ve asked for, what analysis they are working on and what kind of an analysis we’ll get to see.”
NCBA leaders are already pushing a potential fix: a forced one-second delay after each bid, which they believe would diminish the influence of automated high-speed trading.
“It’s not about slowing down the market, it’s about leveling the playing field,” Greiman said.
Cattlemen aren’t the only ones concerned about high frequency trading. Recent efforts to launch an alternative exchange, IEX, which is strategically designed to minimize the influence of automated trading and keep the system more equitable, have been widely reported and meticulously documented in a best-selling book, "Flash Boys," by Michael Lewis.
Many cattlemen, including Dickinson, complimented CME officials for being responsive to their concerns. But so far the CME has bulked at implementing a bid delay, saying it would set a precedent that would have board-wide and even global implications. Instead, the exchange plans to institute “dynamic circuit breakers,” a 2-minute pause in the market that kicks in if large moves occur within a 30-minute time span.
CME representative Tony Drake said during the meeting that the new measure was scheduled to take effect by mid-September.
The committee also discussed possible changes to contract specifications and delivery requirements with the intention of making them better fit the needs of the market.
At the current time, the futures market is steeply discounted relative to the cash, which indicates a lack of rationality perhaps due to a shortage of information.
“The basis is so wide that we have no confidence in hedging cattle right now,” Nebraska’s Uden said.
During the meeting, cattlemen argued the merits of a fed heifer contract, whether to support raising the percentage of choice cattle in the standard fed contract from 55 percent to 65 percent, and whether Worthing, South Dakota, was still an effective delivery point.
Underlying the discussion was a widely held goal of attracting more long positions into the market to balance out the demand for short positions. (Short positions typically represent feeders or producers hedging cattle on the board, while long positions typically represent the packers that will take actual delivery of those cattle.)
Greiman said the committee would need to tap the expertise of academic economists to help drill down into the implications of the various options.
“There are all these ideas: let’s cash-settle, let’s lower the weight, let’s add heifers, let’s get rid of heifers,” he said. “But what we need to look at before we make our decisions is this: how do these things we think we want impact the economics of the cattle market?”
During the meeting, the CME’s Drake told the committee the exchange would like to create a formula for a “living, breathing” contract, which could seamlessly adjust to changing conditions in cattle inventories and demand.
The idea sounds good, but Greiman worried it would be hard to accomplish.
“Try to imagine writing a rule to adjust on-the-fly based on what we see happening three weeks prior to delivery,” he said after the committee meeting concluded. “It gets complicated.”