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eastern Nebraska | My thoughts might be worth close to zero on this topic, but apparently you and I think about a lot of the same kind of things...
1) A market exists to bring buyers and sellers of a good or service together. Period. That is it's function. The market is not emotional. It's participants, however, are another story. :)
2) A futures market may exist where there are enough participants in the production and consumption of a good or service that such good or service may be "standardized" into a contract which "works" for the vast majority of producers and end-users in terms of usefulness as a hedging instrument. In order for that contract to be useful as a hedging instrument, there must be reasonable convergence of contract price at expiration to the spot cash market.
3) For the moment, because it is a different argument altogether, let's just assume the most efficient way to hold a futures market in the US is through a single exchange where all buyers and sellers must come together at a central location (The CME/CBT pretty much has a monopoly on corn futures in the US -- ICE is not even remotely a player right now).
So, the question is: Since there is effectively just one futures market, does the contract on that exchange effectively converge with the cash market at expiration in a manner acceptable to the vast majority of producers and end-users of the underlying cash market? In other words, does it work as a hedging instrument?
Since corn and beans are my background and probably of most interest here, I'll opine on those (I think wheat is a little different discussion due to the various classes and users, and I'm not as familiar with those contracts). When the contracts were first standardized, the export market was key in setting price throughout the country. And Chicago was the center of that universe. Thus the contracts were written with delivery terms along the river export facilities (The difficult terms of delivery on those contracts is also another argument). So in the simplest terms to me, it comes down to the question of: Does the export market provide useful price discovery for US corn and beans, and thus proper convergence between futures contracts and the cash market?
In my opinion, things have changed. And therefore, so should the futures contracts. We still export over 40% of the bean crop, probably over 50% when including meal exports. So I suppose that I can accept the argument that the export market still sets the price in beans. BUT, when you see what's gone on the past week in SU14 as we near deliveries with cash markets trading in multiple dollars over the futures, it makes you wonder...
Corn on the other hand has completely changed. We only export around 12% of the crop now. While exports can still be a price driver, they just aren't nearly as important as they used to be. Domestic competition is where price discovery is primarily set. I think 2012/13 basically proved the contracts are broken. We had an extended bear futures market, where the bull spreads worked and basis strengthened. That's not a market that "works" as a hedging instrument for producers or end-users. When basis volatility becomes over 30% of your risk, the underlying is not doing it's job for the participants it is intended for. I just still don't think you'd get enough liquidity traction to bring back the state basis futures contracts, so as a matter of practicality the futures market contract should be tailored to provide the most amount of use to the vast majority of producers and end-users.
So, I think it is time -- in corn especially -- that we move to a cash settled corn index. Maybe beans and wheat too. If the makeup of the market changes down the road, change the contract again. They changed Live Hogs to Lean Hogs. They changed Feeder Cattle to an index settlement (which after all the volatility there lately is pretty tame this week in August expiration). How the index is derived is another discussion, but I'm pretty tired of seeing the basis shenanigans along the river by our export oligopoly during expiration in order to give the contrived appearance of convergence.
Edited by LODI 8/26/2014 18:35
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John Burn's question the other day.
