By Kelsey Gee
CHICAGO -- Wild swings in the cattle futures market have
prompted some traders to call it "the meat casino."
In response, the world's largest futures exchange has refused to
list new contracts, leaving ranchers with fewer tools to hedge the
$10.9 billion market. CME Group Inc. said that is because trading
of physical cattle has become so scant that the futures market
can't get the signals it needs to set prices.
"It's madness. The market makes major moves for no reason," said
Blake Albers, a cattle feeder in Wisner, Neb.
The decision to delay new contract listings is the culmination
of alarms raised by the exchange and industry groups this year that
problems in the physical marketplace have affected futures -- a
highly unusual meltdown in a market that has attracted more
speculators.
Few producers complained as cattle prices surged to record highs
in 2014 and early 2015. But as prices this summer sank to five-year
lows, financial strain on the industry has highlighted the extent
of the problem. Revenue from cattle sales is forecast to drop 3.9%
this year to $73.6 billion, after falling 5.7% in 2015, according
to U.S. Department of Agriculture data.
Live-cattle futures climbed as high as $1.4155 a pound before
free-falling to $1.1580 over seven weeks this spring. That
represents a more than $10,000 drop in income for a single
contract. Many producers have lost money as prices tumbled to a
five-year low of $1.07525 a pound this summer.
"Guys like me who have been around a long time aren't putting as
many positions on," said Dan Norcini, an independent
livestock-futures trader in Coeur d'Alene, Idaho. "It's just not
worth the risk anymore, when there's no rhyme or reason to these
price swings."
Through July, futures volume fell 1.9% compared with the same
period in 2015, and was down 9.7% from 2014, according to CME
data.
Each futures contract represents the obligation to buy or sell
40,000 pounds, or around 35 head, of cattle. While few traders
actually deliver or receive livestock, they look to the price of
cattle sold at auctions and at feedlots to keep futures prices
anchored to the real world. But structural changes to the way
cattle are bought and sold have made it harder to see physical
market prices.
For nearly a century, meatpackers and producers would haul
animals to stockyards and auction barns, to physically buy and sell
thousands of cattle almost daily for cash. But over time they found
it inefficient and expensive to travel miles with cattle in tow to
barter over pennies and nickels per pound, so many buyers and
sellers gave up negotiating each day.
The number of participants negotiating prices started to
decrease in the 1980s and today, only small number of cash trades
-- which take place just once or twice a week -- serve as a proxy
for the base price used by the rest of the industry. Most of the
cattle delivered to slaughter plants today are priced using a
formula that incorporates the cash market value as a base, plus or
minus premiums and discounts.
"Someone sells 40 head in Iowa and it has the potential to
revalue all the cattle in the nation," Mr. Albers said.
The deals that do take place between cash market buyers and
sellers frequently end up being completed on Friday after the 2:05
p.m. ET close of the futures market. That means financial traders
spend most of the week with limited up-to-date data.
"There is very little underlying information to use," said David
Lehman, CME's managing director of commodity research. The CME has
listed only one live-cattle contract since March and it is set to
expire in October 2017.
The CME has formed a working group with cattlemen to discuss
fixes, including ways to increase the number of cash traders. The
exchange shortened trading hours for the livestock futures
contracts in February to confine market activity to the daytime,
when liquidity is higher, after ranchers complained that
speculators had too great an impact on prices in the evening
trading.
"Every aspect of the cattle futures contract is under review to
see if there's a way to redesign so it's a more effective tool for
risk management," Mr. Lehman said.
The failure to list contracts after October 2017 is a problem
for ranchers buying calves this summer. They typically need around
18 months to grow to slaughter weight, meaning ranchers are exposed
to possible price swings in the 2017 winter.
Steve Sunderman, a partner at a feedlot in Norfolk, Neb.,
recalls watching cattle futures prices earlier this year rise and
fall by more than one cent in just 15 minutes, unprecedented leaps
in a market more accustomed to daily moves of fractions of a penny.
The swings made him uneasy about locking in a hedge for his cattle
on a Friday, when prices had climbed over $1.15 a pound only to
settle at $1.12975, thinking the market would likely climb
further.
"You lose confidence in your decision," he said.
Some in the cattle industry blame high-frequency traders who can
place or receive orders more quickly, and with more money, than
bona fide commercial hedgers -- often located in rural ranching
communities.
But CME said that opening up markets to a diverse group of
investors, including hedge funds and algorithmic traders, adds
liquidity to products like cattle futures, which tend to be more
thinly traded than gold or oil. Just 10% of the total volume in
live-cattle futures came from high-frequency trading in 2015 for
which the latest data is available, the exchange said.
"We need to figure out why the cattle market can go from $1.30
in one week to $1.15, when we haven't added more cattle to the
marketplace," said Ed Greiman, an Iowa farmer who sells about 100
cattle a week and is leading a cattle-marketing committee at the
National Cattlemen's Beef Association.
The solution will have to involve addressing the level of
activity in the barns and feedlots, according to cattle industry
groups and the exchange.
Some producers are trying to find their own solutions. Superior
Livestock Auction LLC, an Oklahoma City-based livestock-marketing
firm, piloted a video auction program to broker sales of
slaughter-ready animals that would mirror sales in the cash
markets, showing bids and offers in the middle of the week.
Interest in streaming the auction online has been so strong that it
has crashed Superior's website in the most recent sales.
"The hope is to add a transparent venue for price discovery,"
said Jordan Levi, a cattle feeder based in Oklahoma City who
spearheaded the initiative. "It's not a playground. This is U.S.
agriculture, and futures should be a risk management tool."
Write to Kelsey Gee at kelsey.gee@wsj.com
(END) Dow Jones Newswires
August 17, 2016 19:25 ET (23:25 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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