Category Archives: Futures Markets
Let’s cut to the chase: PFG makes the futures industry look really, really bad. The best thing that can be said about this debacle is that missing client funds are denominated in millions instead of billions. That’s about it. From MFG, we learned that rehypothecation means that brokers can use client funds as margin for their own trading activities (see here and here), as long as they kept them ‘segregated.’ Such segregation is likely pretty easy right up until the margined trades start losing money, at which point settlements have to be made. In fact, it is worry about those settlements that causes firms to require collateral in the first place. This brings to mind the quote in the latest Economist about the LIBOR scandal, “With traders, if you don’t actually nail it down, they’ll steal it.” But in MFG’s defense, all indications are that the violation of segregation happened pretty shortly before the firm’s collapse. This is little consolation to account holders, but at least we can say that under the (admittedly ridiculous) regulations permitting rehypothecation in place at the time, many parties, regulators included, got blindsided.
But PFG is entirely different. According to recent press reports, in 2010, they claimed to have over $200m in segregated deposits at US Bank, and PFG sent a confirmation to the NFA to that effect. Now it turns out that, in fact, PFG had less than $10m on deposit at the time, and that was in 2010! How does that number go unchecked for at least a year and a half? Did they submit a note from their mother with it, too? Maybe they used nice words like ‘Please’ or ‘Ma’am’? Starbucks gift cards? At the very least, shouldn’t the external auditor have checked it? The NFA? The CFTC? The CME? Anyone? I’m not sure where to start describing my confusion about this. This just seems so simple to catch, and yet it wasn’t caught.
Which leads to the obvious question: how can anyone trust the futures markets? How far have we really come from the bucket shops that featured so prominently in ‘Reminiscences of a Stock Operator?’ Yet these markets are vital to the operation of the modern economy. Without modern futures markets, the amount of risk borne by everyone in the commodity chain would increase dramatically. Farmers couldn’t hand their risk off to elevators through forward contracts because elevators wouldn’t be able to hedge the risk arising from the forward contract. Tyson’s wouldn’t be able to offer forward prices on their chicken to Wendy’s because they not only couldn’t hedge the feed exposure, but they wouldn’t even know what future feed prices will be. The result would be much higher operating costs for everyone.
What can be done? For the time being, I think that the CME and the ICE should once again open their wallets, first as a sign of bona fides to those who lost money; second to lobby for the extension of SIPC-like protection to futures and options accounts. I have to admit that I was shocked to learn that those protections don’t exist. Second, could everyone (CME, ICE, clearinghouses, NFA, CFTC, auditors) please sit down around the same table (I bet Senator Grassley could arrange a table…) and figure out whose responsibility it was to pick up the phone to US Bank and why it didn’t happen? Third, could that person, their co-workers, or someone please lose their job? Fourth,could someone from PFG go to jail?
Sadly, only the fourth will happen.
The February crop reports released this morning were pretty boring. While the revisions were somewhat on the bearish side of expectations, the directions were all as expected.
One of the biggest areas of concern has been the continued drought in South America. Over the past few days, and even up to last night, various official and semi-official sources in Brazil, Argentina and Paraguay have been reducing soy crop estimates. As of the latest reports that I’ve seen, the current in-country estimates (Feb USDA) are Brazil 69.2mmt (72), Argentina 47 (48.9), Paraguay 4.6 (6.4), for a total difference of 5.6mmt, or 205m bushels.
Global Soybean Production, Use & Stocks/Use
As you can see in the plot of global soy production, usage and stocks/use, if one incorporates the newly lowered production figures, and assumes that about 40% of the lowered production will be offset by rationed demand, we move to a 23.5% stocks/use from a 24.5%. This is slightly above 07/08. The WAOB expects that the drought will increase US exports, and it is reflected in the February revisions by the fact that even though exports are currently running below the 11/12 levels forecasted in the January report, the US should book additional exports in the coming months based on lower availability out of SAm. I agree with this, but I think I’m less optimistic than many in the trade. With some luck, I think that we can increase our exports 60m bushels from the current estimate of 1275m bushels, which would tighten US ending stocks, but, in my opinion, only enough to justify the price move that we’ve seen in the past month in beans, and not more.
From the inbox:
The CFTC has just released two new reports looking at volume in various commodity futures and confirming what most have already known, namely that under 10% of daily futures volume in the most popular products comes from Large Trader position changes. The balance or well over 90% in most cases, originates from “daytrading” accounts, or said simply, speculators dominate price formation on the margin for the bulk of products, which also means that longer-term equilibrium levels, those determined by supply and demand, are largely washed out when all the daytrading, and thus short-term pricing, mania is factored in. This also explains why moves such as the recent desperate SPR release by the IEA are generally doomed to failure. The CFTC’s Gary Gensler said that “The data shows that, in many cases, less than 20 percent of average daily trading volume results in traders changing their net long or net short all-futures- combined positions. The balance of trading is due to day trading or trading in calendar spreads.“
(original source here)
- Does anyone know if such data was collected previously, say, twenty or thirty years ago? I’m just curious how this would compare. Many people seem to think that this number is obviously much too high, but with neither context nor empirical/theoretical justification.
- What is the Large Trader database? Simply that, it is the data from the daily submission of Form 102 and Form 40 submissions by firms with ‘large positions,’ based on open interest. The current minimum levels are here. According to the CFTC’s “This Month in Futures” such large traders account for about 94% of OI on CL, 90% on C-, 94% on W-, and 75% on SP.
- The ‘Large Trader Volume’ that is quoted in the slides will be biased downwards because it only accounts for changes from at a weekly frequency, but it is comparing it to all volume.
- Why is spread trading so wrong? Last I checked, it was an integral part of physical hedging. But maybe things have changed in the past 12 months…