It's a Commodity Business

From Beans to Bellies, Food Futures are the Original Derivative

Nov 23, 2008 Dean Lundell

There is a market for everything. Can a well fed investor take advantage of agricultural markets?

A statue of Ceres, the mythological Greek Goddess of Grain, adorns the top of the Chicago Board of Trade and her two-story picture graces the atrium of the new CBT Annex. Agricultural market futures have been traded for decades – the first derivative.

The Grains

Some people have a difficult time understanding this concept: Farming is a risky business. High fixed costs, volatile supply and demand curves and even being at the mercy of the weather around the globe all contribute to a very uncertain outcome from any spring planting. That is why farmers are the first legitimate hedge accounts in the futures markets.

Corn

One of the factors that can dramatically change the slope of a demand curve is a new or expanded use of an old product. Corn, which has been grown for thousands of years, is a perfect example of this, as a principal by-product of corn is ethanol. The recent significant rise in the price of crude oil and petroleum products made ethanol an attractive alternative and thus corn saw an expanded use and the resulting rise in price. Recent declines in the price of oil have been mirrored by declines in the price of corn.

Soybeans

Soybeans have been used as a food staple for about 5,000 years and in more recent times as an ingredient in many processed foods, including dairy substitutes. Soybeans are grown around the world and provide both vegetable oil and meal which is used as animal feed. There are many health claims and counter claims surrounding the consumption of soy products. Futures contracts are traded on the beans themselves, the oil and the meal. The combination of positions in all three is known as the "crush."

Wheat

After corn, wheat is the second largest cereal crop and again, is grown around the globe and has been for millennia. Wheat is a principal source of flour for breads, pasta and cereal as well as beer and other alcohol products. Wheat is typifies the price volatility due to global climactic condition, having seen dramatic price rises and declines over the past several years due to freezes, floods and droughts.

There are also markets for oats and rough rice in addition to corn, soybeans and wheat.

The Meats

The meat market primarily consists of contracts on live cattle, feeder cattle, hogs and pork bellies (bacon). Due to the fact that cattle and hogs are fed grain, there is a correlation between these markets. One of the actively traded spreads is the hog vs. pork belly spread. The price spread between the two expands and contracts just like any other spread, with bellies having a certain value added over hogs.

Dairy

The dairy market is one that does not see a great deal of retail participation. Similar to other products, milk, whey, butter and cheese are consumed directly or are used in many other processed food products. Thus, hedge that either grow or use these products tend to be the primary market participants.

Participation

Your participation in these markets demands that you know these markets and the factors that affect them like any other market. Investors and traders should also be cognitive of the value of a contract, the price volatility and the required performance bond (margin).

Caveat Emptor

The copyright of the article It's a Commodity Business in Investment is owned by Dean Lundell. Permission to republish It's a Commodity Business in print or online must be granted by the author in writing.

A Future in Food?

What do you think about this article?

---

NOTE: Because you are not a Suite101 member, your comment will be moderated before it is viewable.

post your comment

What is 1+1?