The following editorial was published in Price Perceptions issue #1357 on March 15, 2008

Dysfunctional Markets - Part I

What one person perceives as perfectly normal, another views as irrational. For instance: Many commodity traders view the Fed’s bailout of banks holding sub-prime mortgages as inflationary... In response, funds bought Chicago wheat futures and pushed prices for a test of historic highs at $12.65 per bushel. Others viewed this response as completely irrational... Pointing to the illogic of longs holding 2.1 billion bushels of wheat in a market representing a crop of only 360 million bushels. What does this tell us? Who is right in their assessment?

Billions of dollars are moving into index funds and Exchange Traded Funds (ETF’s) that buy commodities. Those funds must buy futures, regardless of price levels or how irrational it may appear. These funds have pushed futures so high that US soft red wheat for new crop delivery is trading $1.70 to $1.90 per bushel over European prices. In fact, cash market bids for new crop Chicago wheat are currently $2.00 per bushel below futures (if you can find a bid). Which market is rational... The one reflecting cash values or futures?

Funds have pushed futures well above prices that users are willing to pay in cash markets. Therefore, large and small grain firms can no longer afford to hold grain in storage and maintain short hedges in futures. Processors have gone to “cash markets only” to buy soybeans and will no longer contract for delivery from country elevators or farmers for spring and summer months. They have also halted sales of meal for spring and summer delivery, as they have no way of knowing what they will have to pay for cash soybeans. It has become obvious to those in the cash grain business that markets have become dysfunctional.

It became obvious in the late Nineties that internet stock prices had become irrational. After all, many of the larger internet firms had never made a profit. However, their stock prices continued skyward and whiz kids became billionaires. But, rationality returned to the marketplace in the early 2000’s and the market for those stocks became dysfunctional.

In recent years, home prices advanced by the greatest margin in history. Speculators bought condos before they were even built and turned profits by selling to another speculator. However, rationality returned last year as funds, banks and insurance companies refused to buy sub-prime mortgages. Now, the market for mortgages has become dysfunctional.

Futures and cash grain markets have become two separate and distinct entities. The separation has entered a dysfunctional stage… But, which market is irrational? Will cash grain users eventually be forced to pay futures prices… Or, will speculation run its course and futures succumb to cash markets?

As my friend, Dennis Gartman, editor of The Gartman Letter, says: “Irrational markets can last longer than your money.” Grain futures appear irrational and dysfunctional, but the bull market could last longer than many of us expect.

Bill Gary
CIS, Inc.


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