Two Markets

To be an effective and successful grain marketing person, one absolutely must fully understand that there are two grain markets, how those two markets function and how they are connected to determine cash grain prices.

For this discussion, the term “cash” market refers to goods of monetary value (corn, wheat, soybeans, hogs, rice, cattle, etc) which can readily be exchanged for green cash dollars. The word “grains” will be used to include not only grains (corn, wheat, oats, rye, barley), but also oil seeds (soybeans, rapeseed, canola, peanuts, coconuts, olives, cotton seeds).

Cash Market

The cash market is simply the market in which grain is exchanged for cash… in other words, sold to a buyer in exchange for cash payment. A grain producer delivers grain to a grain elevator where it is weighed, graded and the farmer receives a cash payment. Anyone who has ever had cash in his pocket knows the cash market because our society is primarily a cash market. People buy groceries in the cash market, they buy repair services and parts for their vehicles and machinery with cash; they buy almost everything with cash. Businesses buy their employees’ labor with cash. Get the picture?

A bushel of corn is 56 pounds of shelled corn, whereas 60 pounds of soybeans and wheat equals a bushel. The standard grade is USDA grade number 2 for all grain commodities. Elevators post their cash grain prices in dollars and cents per bushel for number 2 grade. If there are no discount deductions (for excessive moisture, damage, etc) from whatever the elevator’s posted price is at that moment, that is the price paid in cash for the grain. The cash market price is sometimes called the “spot” market. The “spot” price is the price of a given commodity at that moment.

The cash grain markets are regulated by the various states’ Departments of Agriculture. The Ohio Department of Agriculture (ODA) has a Grain Warehouse Division which consists primarily of a group of auditors who routinely inspect the record books of the grain dealers holding an Ohio Grain Warehouse License, which is renewed annually by the ODA Grain Warehouse Division. Auditors verify that an elevator, which ODA refers to as “Grain Warehouse”, has the financial reserves to pay for grain the elevator has bought, but has yet to pay the seller. Physical bushels which must be “in house” include grain that is on “commercial storage” and designated as “grain bank”.

Commercial storage grain is expected (but not required) to be sold to the grain warehouse at a later date and grain bank grain is expected (but not required) to be returned to the farmer as feed for livestock. Grain on “delayed price” (DP in Eastern Corn Belt, price later contracts in the Western Corn Belt) and “basis contract” grains are NOT required to be in-house, but if the elevator has sold that grain, the elevator must have the financial reserves to pay for that grain upon demand by the farmer.

Typically, a grain warehouse will be audited by the Department of Agriculture once per year, but not necessarily every year. The ODA is free to audit any grain warehouse as many times a year as it so desires and ODA will do just that if the ODA determines the elevator is on the fringe of being out of compliance. ODA is authorized by law to take over the management of an insolvent elevator for liquidation of its grain and cash assets to best protect farmers from financial loss. Elevators may or may not be informed in advance of a scheduled audit.

In the final analysis, if a grain purchase and sales contract requires physical delivery, it is a cash grain contract and subject to state regulations and authority. If delivery is not required, the contract is a futures contract. This designation can be a very important fact if financial problems arise for the elevator or the farmer.

Futures Market

The second market is the Futures Market. Although cold, hard cash is the lifeblood of the commodity futures market, it is NOT a cash market! A person must have a commodity futures trading account with a brokerage firm to trade commodity futures. To trade the cash market, it just takes cash or a physical commodity.

The futures market is a market of contracts; contracts which are bought and sold for a specific commodity of a specific quality for a specific price for delivery during a specific month. It might be easier to comprehend a futures market contract as a “promise”; a promise by the buyer to take delivery of the physical commodity and a promise by the seller to make delivery at a later (future) date.

A “trader” is any person or business which takes a futures contract position. There are two types of traders, namely “hedgers” and “speculators”.

A hedger is a futures trader who takes a futures market position opposite of his position in the cash market. If a trader owns corn in his bin or in his field, he is a hedger when he sells corn in the futures market. If a trader feeds corn to his livestock and buys corn in the futures market to lock-in feed costs, he also a hedger. A hedger trades the futures market to reduce his risk of price change in the cash market. As the commodity price changes, a hedger makes money in one market and loses money on the other market; the gain in one market is offset by the loss in the other market.

If a futures trader does not own any physical inventory and has no plans or desire to own the physical commodity, he is a futures market speculator. A speculator is a trader who is willing to accept the risk of losing money in exchange for the opportunity to make money on price change. As the commodity futures price changes, there is nooffset of the futures gain or loss in the cash market for a speculator.

All hedgers are traders and all speculators are traders, but not all traders are hedgers nor are all traders speculators. It is very important to understand this concept of the two types of traders because one seeks to increase his market risk and the second seeks to reduce his market risk!

The primary difference between the cash market and the futures market is physical delivery is not required on futures contract and physical delivery of the commodity is required for cash grain market contracts.

If a trader takes a futures market position, to avoid physical delivery, he must offset that futures position with an equal, but opposite futures transaction before the delivery month arrives. Otherwise, delivery of the physical commodity must be made by the futures contract seller and accepted by the futures contract buyer. If a futures contract is offset by an equal, but opposite transaction at a later date, before delivery, the commodity futures exchange simply credits the account of the trader who made money with the profit and deducts the loss from the trader’s account who lost money and the transaction is complete.

A trader can sell a futures contract first and buy a futures contract at a later date to offset the sold contract. Such a transaction is called a “short sale” and the trader is “short the market” or simply stated, “short”. A trader who buys a futures contract before he sells the contract is “long the market”, or, simply stated, “long”.

The short position makes money if the price goes down. The long position makes money if the price goes up.

Commodity futures markets are regulated by federal government via the Commodity Futures Trading Commission (CFTC) which is authorized by the Commodity Exchange Act (CEA).

The Chicago Board of Trade (CBOT) was organized in 1848. In 1872, a group of Manhattan dairy merchants got together and created the Butter and Cheese Exchange of New York. Soon, eggs became part of the business conducted on the exchange and the name was changed to the Butter, Cheese, and Egg Exchange. In 1882, the name was finally changed to the New York Mercantile Exchange (NYMEX) when it opened trade to dried fruits, canned goods, and poultry. The Chicago Mercantile Exchange (CME) began in 1898 as the Chicago Butter and Egg Board, so named because it only traded contracts in butter and eggs. In 1919, it became known as the Chicago Mercantile Exchange (also called "the Merc”). The exchange greatly expanded its product line over the years, beginning with the introduction of frozen pork belly futures (uncured bacon) in 1961. In 1964, the exchange began trading live cattle and live hog futures. In 1972 it issued the first futures on foreign currencies exchange rates and interest rate futures and, in 1982, stock index futures were added to its product list. Within a few years, the financial futures at the Merc made it the fastest growing futures exchange in the world. The moral of that story is there is a lot more money in the world than there is corn, wheat or beans!

The CME became the largest futures exchange as measured by the number of contracts traded (called “trading volume”) in the world 2001. In July 2007, the Merc bought the CBOT. In August of 2008, the Merc bought the New York Mercantile Exchange and the Commodity Exchange (COMEX), also located in New York. Lastly, in December 2012, the CME purchased the Kansas City Board of Trade. All these exchanges are now referred to as the “CME Group”.

Yellow corn, yellow soybeans, oats, and soft red winter wheat are traded at the Chicago Board of Trade (CBOT). Hard red winter wheat is traded at the Kansas City Board of Trade (KCBOT). Hard red spring wheat is traded at the Minneapolis Grain Exchange (MGEX).

In the final analysis, if a contract does not require physical delivery, it is a futures contract and subject to federal regulations and authority. All futures contracts must be traded on a federally regulated exchange or they are illegal and the penalty for off-exchange trading of futures contracts is very severe.

If a grain elevator offers you cash grain purchase contract and physical delivery is optional, the elevator and you, if you sign their contract, are violating the CEA.

In 1996 and 1997, many elevators and farmers went out of business over lawsuits trying to sort out what was a futures contract and what was a cash contract. Make sure you know the difference. The last thing you want are the Feds showing up at your farm and charging you with illegally trading off-exchange futures contracts at your local elevator.

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