The Tail That Wags the Dog

January 10, 2021

Author: Guy Soreq

On March 13th 1851 a farmer signed a contract promising to deliver 3,000 bushels of corn to Chicago the following June at a price of one cent below the current cash market price. This trade is the first recorded forward contract that allowed farmers to reduce their risk and gave buyers a means to purchase their goods. The huge success of this method brings us to the present day, when every bushel of corn grown is traded an average of 12 times before a final customer receives it.

This increase in trade offers the market three major advantages: risk reduction against the change in market price, cash to finance the capital intensive and lengthy act of farming, and information for decision makers regarding the market’s expectations of future economic events.

With these factors in place, farmers and merchants could secure larger loans more readily and at relatively lower rates, so long as they obtained firm price and quantity commitments from their buyers.

As the world became more flat, forward contracts for commodities took on another role. The price of corn traded on the Chicago Mercantile Exchange (CME Group) impacted not only corn trades on the other side of the world, but also products derived from corn such as amino acids and other fermented goods. So while every real bushel of corn is traded an average of 12 times on the CME, the number of trades related to corn derived products or just corn unrelated to Chicago is much much greater. So how can a single price of corn on the Chicago Mercantile Exchange possibly capture the variety of trades happening around the world?

In short, it can’t. While the CME price is intended to reflect a global price, an Argentine farmer is unlikely to find it useful in his or her day to day work. We know, because we’ve spoken to farmers using Glowlit. Before Glowlit, many farmers had nowhere to turn for reliable affordable information on real-time prices. Speculators, on the other hand, have no shortage of data for purchase. The largest speculating firms buy market intelligence reports for tens of thousands of dollars to understand crop conditions, weather forecasts, and growth in GDP - all to form a best guess as to the supply and demand at some future point in time.

And herein lies the real problem.

The lack of market transparency between Chicago and Argentina, coupled with the high cost of accessing what little data is available, creates the perfect conditions for speculators to be the tail powerful enough to wag the whole darn dog. With the whole world basing decisions off of a singular number, any slight fluctuation risks an avalanche of speculators looking for their next big opportunity. And in the zero sum game of trading, their opportunity is at the expense of those who produce, trade and buy actual product.

This is the problem that Glowlit aims to solve. Although we see futures markets as a critical tool for reducing the risk to the farmer, the scale of trading by speculators has led to a massive increase in market volatility. At Glowlit, we aim to empower everyone along the supply chain with data, and in doing so diminish the disproportionate power the tail currently has over the rest of the dog. We’re striving for true market transparency, from Chicago to Buenos Aires.

Photograph: SensorSpot/Getty Images