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Technology and Trade

The topic of high frequency trading (HFT) of equities and commodities has become all the rage. The CFTC, the SEC, the FBI and New York's attorney general are all investigating it. However, the subject has really taken off as a result of financial writer Michael Lewis's latest book entitled "Flash Boys: A Wall Street Revolt," which is about a group of computer nerds who use HFT programs to gain an unfair advantage over less technologically-adept investors. The financial press is also filled with discussion about the matter.
It is a concept, though, that has been around since at least 2005 when computer trading programs that use electronic trading platforms to match buy and sell orders were developed and really took off. Cheaper and faster electronic trading at exchanges began to account for a significant and rapidly growing percentage of an exchange's total trading volume at the expense of traditional trading by open outcry.

Back when we were much younger, commodity futures markets were much simpler in many respects than they are today. In those days, what might be called HFT occurred at lunch time when brokerage clients left their workplaces and headed to their broker's office to eat a sandwich, watch the quote board and place a few orders as it was usually faster than doing so by phone. Veteran CBOT pit traders often counted on a brief lunch time rally resulting from orders from brokerage clients as they ate and stared at the board.
How things have changed! Trading in which an exchange computer system automatically matches buy and sell orders encouraged the development of computer trading systems that automatically create the buy and sell orders. Electronic trading now typically accounts for 90 percent or more of the CME's total trading volume.

HFT is executed by computers placing large buy and sell market orders through electronic trading platforms operated by exchanges using algorithms and advanced technical systems that anticipate and cash in on tiny price movements. The margins per unit of trade, if any, earned by these black box algorithmic trading programs are usually extremely small, but become large sums of money when multiplied by the large volumes typically involved. Contrary to technical trading systems that track price momentum, HFT programs trade in the very short term. They seldom carry a position at the end of the trading day. By now, every successful equity and commodity exchange provides electronic trading that is available most of the 24 hours of every trading day. An example of an exchange-operated electronic trading platform is CME's Globex. A few have also retained open outcry trading alongside for a part of each day, despite the small portion of their respective volumes accounted for by open outcry trading. How long exchanges will carry open outcry trade is a question.

The main questions being raised are these: Does HFT give its operators an unfair advantage over ordinary investors? Does HFT distort markets? If so, is this done in ways that breach regulations and/or commit crimes? Needless to say, these questions generate a wide difference of opinions.



(This article was originally published in the 3 April 2014 issue of Ag Perspectives as part of a WPI analysis by Bob Kohlmeyer. Click here to find out more about subscribing to Ag Perspectives.)

9 April

Gary Blumenthal is speaking on geopolitical instability and agriculture at the Farm Foundation in Washington, DC.

22 April

Mike Krueger is speaking at the Wheat Procurement Seminar in Jakarta, Indonesia.

24 April

Mike Krueger is speaking at the Wheat Procurement Seminar in Ho Chi Minh City, Vietnam.

The Evolving Business of Farming

The sort of agriculture that surrounded us as we grew up fit a pattern that is now promoted by USDA and others who are into food nostalgia as "know your farmer/know your food." Quite literally, my parents knew many local farmers and purchased eggs or freshly butchered pork from some of them. As we recall, there was a so-called truck farm at the edge of town that grew sweet corn and other vegetables, and our mother was a regular customer when supplies were available during the summer.

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China's economic growth has created a spike in the country's protein demand at the same time public confidence in domestic food safety is at a low. A large majority of Chinese in an Ipsos poll say they have lost confidence in domestically produced food, and 28 percent said they would be buying imported food. The government is revising policies in an effort to respond to both supply constraints and safety concerns, but food imports are now growing at 15 percent per year and are projected to continue on that trend. Chinese companies attracted attention by acquiring major food production and processing capacity in other countries, a move that is likely to continue.

Separately, the government blocked imports of hundreds of thousands of tons of corn from the U.S. after inspecting and finding the unapproved MIR162 biotech event. The trade accuses China of importing corn from other originations without inspecting it.

To read more about the "Year of the Snake" and future prospects for China and agricultural trade, send a message with your request to wpi@agrilink.com and receive a free copy.
As we begin each New Year, it has become our habit to peer into our proverbial crystal ball and make some ad hoc forecasts about the year ahead that are generally related to agriculture and markets.

Predictions

  • As they approach spring planting, U.S. farmers will face corn prices at the lowest levels since 2011 and soybean prices at the lowest levels since early 2012. The soybean/corn price ratio will tilt toward soybeans. Relatively high input costs for corn will also favor soybeans. However, without high prices to skew planting decisions, standard crop rotation practices will resume a more prominent role.
  • We predict that U.S. farmers will plant 93-93.3 million corn acres, down 2-2.3 million from 2013. Soybean acres will be a record high 80.5 million, up 4 million from 2013.
  • The U.S. will experience another reasonably good growing season, although probably not as extended as during 2013. Planting will be timelier than in 2013. Soybean and wheat yields for the 2014 crops will be close to 2013 levels, but the corn yield will be slightly higher. Corn production will be about 13.8 billion bushels, the soybean crop will hit about 3.45 billion bushels and all wheat production will reach close to 2.3 billion bushels.
  • There will be some weather-related crop production problems around the world, but none significant enough to change longer-term market direction. U.S. ending stocks of wheat, corn and soybeans will grow larger in 2014/15 with corn stocks over 2 billion bushels, considered to be surplus by some analysts. World 2014/15 soybean stocks will set another record.
  • Market price action will be much less volatile than during the last several years with prices comparatively lower, but still well above historic averages.
  • Markets may not pay much attention at first, but lower prices will encourage increased demand and consumption. Demand for grain and oilseeds will set new records during 2013/14 and again in 2014/15, led by rebuilding of livestock and poultry numbers.

Macro View

  • The U.S. economic recovery will pick up steam, but still slowly. U.S. GDP will grow about 2 percent in 2014. Unemployment will remain a sticky problem holding at 7 percent.
  • The political impasse will not be as strident, but both sides will play for the 2014 midterm elections. The Republicans will enlarge their majority in the House and will pick up Senate seats, but not quite enough for a majority. The Democrats will retain a 51-49 or 52-48 majority. With the prospect of a split Congress for the rest of his term, President Obama will continue to use executive actions to bypass Congress as well as existing law.
  • A farm bill finally will be passed, probably by March.
  • The EU's economy will finally begin to grow. GDP will expand about 1 percent in 2014. Greece and Portugal's problems will persist, but not in ways that threaten the EU or the euro. France's problems will grab the publicity.
  • China's economy will slow and stutter with a GDP around 7 percent. Demand for raw material commodities will stay flat. Soybean demand will grow only slightly in 2014, although modest expansion of hog and poultry numbers will produce enough demand for soymeal to keep crush margins at least slightly positive most of the time.
  • There will be little improvement in the Middle East. Syria will remain stuck in a civil war that neither side can win. Negotiations over Iran's nuclear ambitions will garner a lot of publicity but little, if any, concrete results. The Shite-Sunni conflict in Iraq will worsen. Unrest and an unsettled economy in Egypt will continue to pose problems.

What we are unable to forecast are the inevitable surprises that always appear. No doubt there will be some in 2014, but they are unlikely to halt the agricultural market's changeover from one made tense by demand and concerns about the adequacy of supplies to one in 2014 that must accommodate larger supplies and hope for greater demand.

A supply-driven market is not a permanent change any more than was a demand-driven market. Both are parts of an ongoing cycle with neither more than one crop year away from a change.

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Current Analysis

USDA's Economic Research Service recently released its farm financial analysis that includes assets, debt and equity forecast to the end of 2013. It's a timely report given the drop in crop prices, the unclear status of the farm bill and its support programs as well as the uncertainty of the renewable fuel standard (RFS) going forward into 2014 and 2015. The biggest factors are net farm income and debt levels.

Income
Net farm income is forecast to be $131 billion in 2013, up 15.1 percent from 2012's estimate of $113.8 billion. After adjusting for inflation, 2013's net farm income is expected to be the highest since 1973. Substantial year-end crop inventories are expected as a result of the record corn harvest. Net cash income, which measures the difference between cash expenses and the combination of commodities sold during the calendar year plus other sources of farm income, is forecast at $129.7 billion. That is down just over 3 percent from 2012. In spite of this and after adjusting for inflation, 2013's forecast would be the fourth time that net cash income has exceeded $100 billion since 1973.

Debt
Farm debt is broken down into real estate debt and non-real estate debt. Real estate debt for 2013 is projected to be $180.2 billion, 4.2 percent above the estimate of outstanding real estate debt at the end of 2012. Cheap interest rates have helped prop up farm real estate prices and high crop prices have helped keep land prices elevated. Additionally, increased crop prices have kept income high. That enables larger down payments and less debt financing. The Farm Credit System is the largest lender to farm real estate debt with commercial banks in second place.

Non-real estate debt (operating loans, machinery and buildings) is forecast to be $130 billion in 2013, up 2.1 percent from 2012. Higher input prices for feed, especially in the livestock sector, have increased the size of the average loan as opposed to more loans expanding this type of borrowing. Commercial banks are the largest lender when it comes to non-real estate debt.

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Assets
Farm assets are up, pushed largely by increased land prices that have increased 7.5 percent. Livestock herds and flocks are down by about 1 percent, and cash assets will decrease by as much as 10 percent this year with year-end grain prices down. That will start to have an impact on land prices and borrowing.

The bottom line is that farm income has lifted up farm assets and equity. As expected, farm debt to equity and debt to assets are down. We could see a turning point in 2014. Lower income and asset values will soon come into play as will bearish crop prices and the ability to invest larger down payments. Indeed, smaller down payments will mean more borrowing.

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