Commodity Futures with Thinly Traded Cash Markets: The Case of Live Cattle

Transcription

1 Commodity Futures with Thinly Traded Cash Markets: The Case of Live Cattle Ted Schroeder Glynn Tonsor Brian Coffey K-State Ag Economics & Center for Risk Management Education & Research Overland Park, KS April 5-6, 2018

2 Implied Volatility ($/head) Revenue risk rivals record $600 $500 $400 Dollar per Head Fed Steer Market Price Implied Volatility on Four- to Five-Month Deferred CME LC Contract, Daily $515/head BSE Discovery $250 - $450/head $300 $200 $100 $0 Date Source: Calcuated based upon data obtained from USDA AMS and Bloomberg

3 Percentage of Marketings Formula replaces Cash Negotiated 80% 70% 60% 50% Ways Domestic Fed Cattle are Purchased, Weekly March 2018 Cash Negotiated Negotiated Grid Formula Forward Contract 40% 30% 20% 10% 0% Source: USDA, AMS Week

4 Share of Total Negotiated Marketings (%) 50% 45% 40% 35% 30% Annual Average Shares Weekly Cash Negotiated Steers and Heifers, Five Market Region, IA-So. MN NE NE, IA-S. MN 68% TX-OK-NM 7% of 5-Region Negotiated Trade 25% 20% 15% KS TX-OK-NM 10% 5% CO 0% Source: Calculated from USDA-AMS data Year

5 300% 250% 200% 150% 100% 50% 197% 279% Negotiating Intensity 2004 & 2017 Negotiated Share / Fed Mktgs Share 172% 147% 93% 80% 55% 56% 77% 24% IA & NE increasing importance in negotiated trade 100% Neg. Share = Mktg Share TX-OK-NM declined negotiation 0% IA-So. MN NE KS CO TX-OK-NM

6 Basis Difference ($/cwt) Regional price variation: Segmented markets? $10.00 $8.00 $6.00 $4.00 Weekly Difference in Nearby Contract Steer Basis, Kansas minus Iowa-S. Minnesota and Kansas minus Nebraska, Kansas minus Iowa-S. Minnesota Kansas minus Nebraska $2.00 $0.00 -$2.00 -$4.00 -$ Weeks Source: Calculated from data obtained from USDA AMS and Livestock Marketing Information Center

7 Absolute Value of Basis Prediction Error ($/cwt) Predicting basis more difficult: Increased hedging risk $5.00 $4.50 $4.00 $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 Annual Average Absolute Value Nearby Basis Prediction Error Five Major Markets, CO IA-So. MN KS NE TX-OK-NM Year Source: Calculated from data obtained from USDA AMS and Livestock Marketing Information Center

8 Trading Range ($/cwt) Greater daily futures price volatility: Increased hedging risk $3.50 $3.00 $2.50 Monthly Average of Daily Trading Range in Live Cattle Futures Prices January 1990-December 2017 Five- or Six-Month Deferred Nearby $2.00 $1.50 $1.00 $0.50 $0.00 Month-Year Source: Calculated based on data obtained from CRB PowerGen.

9 Contracts work well in homogeneous, underlying physical industry

10 Fed cattle industry becoming more diverse: CME LC becomes a cross-hedge?

11 Beef Differentiation: Increased hedging risk Average Absolute Value of Weekly Predicted Basis Error Negotiated Cash NE Steer and Choice Grid Steer, Negotiated NE Steer Absolute Value Basis Error ($/cwt) Grid Choice NE Steer Absolute Value Basis Error ($/cwt) a Percentage Difference (%) Year % % % % % % % % % % Average %

12 LC Contract Initiatives 1. Contract specification changes Par quality grade; weights; delivery procedures & locations Position limits; Price limits Ongoing challenge aligning with industry pace of change 2. Proposals to cash settle contract Varied and polar industry opinions Need settlement index not subject to manipulation Thin and sporadic cash trade means index tougher to construct Ongoing production differentiation further complicates

13 Government Initiatives 1. Livestock Mandatory Reporting (LMR) Challenge aligning with industry pace of change Renewed/discussed ~ every 5 years Unintended consequences? Facilitated demise of negotiated trade? Comprehensive fed cattle value reporting More information result from collected data 2. Proposals mandating negotiation or other terms of trade Several related discussions & often tacked onto other bills Difficult to manage and align economic incentives Unintended consequences substantial

14 Cattle Industry Initiatives 1. Encouraging negotiation Direct economic incentives not present Market incentivizing negotiation not developed 2. Fed Cattle Exchange Difficult to entice volume given economic incentives Concept retain promise; execution remains challenging 3. Proposals for Blockchain Technology Holds substantial promise for informing market Several challenges (data security; latency; scalability) Some will resist & limit progress

15 Slides after here will not be presented and are simply retained for context.

16 Impacts of Long/Short Goal Diversity not well identified Producer et al. less represented in Long Open Interest: Partial Mis-Match of Goals of Short & Long Position Holders

17 Unclear Cash market information flowing to Futures trade

18 Marketings Share Annual Share of Total Marketings in Five Major Markets, CO IA/MN KS NE TX/OK/NM Year