In his paper -- Disconnections: The Growing Gap Between US Agriculture Futures Markets And The Real World Of Trade In Grains And Oilseeds -- Robert W Kohlmeyer, President, Emeritus of World Perspectives Inc says that the "unsettling trends" are becoming apparent in the price discovery function for agricultural commodities.
The World Perspectives Inc is a Washington DC-based firm providing a wide range of market and policy strategic services to private and public sectors. Established in 1980, WPI serves a global client base operating in food, agrigoods and related industries.
According to Mr Kholmeyer, the disconnect is most obvious in the case of wheat. As wheat production expands around the world and exportable surpluses grow in a variety of "new origins", it seems that the US wheat futures markets are having increasing difficulty keeping up with the changes. The impact of this shift is evidenced by the European Unions efforts to change from using the CBOT as the benchmark for its margin of preference tariff rates on grain. Further, the paper, according to The Journal of Grain and Feed Trade Association (GAFTA), says there is little direct connection between Chicago or Kansas City wheat contracts and the price of bread wheat offered FOB the Black Sea. And neither the seller nor buyer of Black Sea wheat is likely to offset his price risks in US futures markets. The connection between Argentine wheat prices and the US futures may appear stronger but with the political uncertainties, exchange rate risks, shifting taxes and the like, the US markets are an imperfect hedge at best.
The net result is that the world wheat market largely bypasses US cash wheat and US cash wheat increasingly bypasses the US wheat futures market. Therefore, the physical world wheat market becomes even further removed from US futures. Thus, the real question is not when this situation might turn around, but rather if it ever will. The growing disconnection between US wheat futures markets and world wheat values and trade is easier to demonstrate compared to corn or soyabeans. The US remains the worlds largest corn producer by far. China is a distant second followed in 2001-02 by the EU, Brazil, Argentina, India, South Africa, Romania, Canada and Hungary.
World soybean production and trade has become a US and South American game with production in Argentina, Brazil and Paraguay gaining rapidly on US production. There is no doubt that production of many crops has spread around the world, and that some major importers of yesteryear have become significant exporters. India, Pakistan, Turkey and China come readily to mind. As the US share of world trade in agricultural commodities shrinks, it is natural that US markets mean less to world prices and price discovery.
THE SOLUTION: Cash settlement of futures. The only solution that might help solve such problems would be cash settlement of futures contracts instead of settlement via physical delivery. "I never imagined finding myself supporting cash settlement," said Mr Kohlmeyer. "As things have developed, I have come to believe that a switch to cash settlement would make agricultural futures better able to reflect and deal with modern realities," he added.
CONCLUSION: The future of current agricultural futures and options contract is qestionable if not downright pessimistic. At the very least, there will be major changes among existing contracts and for the ways in which they are traded and used. At the worst, it is not hard to imagine that few of them survive. There are simply too many changes for most of todays contracts and institutions of trade to keep up with them. All agricultural futures markets will face the inevitable questions about who will use them and why. At the best, agricultural contracts, already overwhelmed by trade in financial instruments, are likely to become more of a nuiscance factor than a money-maker for whatever venues in which they may trade. It is possible that even on electronic platforms, agricultural contracts may not generate enough revenue to pay their way amidst other more active products.