There’s always a name attached to it: the guy or girl who found themselves more of a speculator than a hedger, and eventually taking a big inverse as a result. Gabe and Rodney connect this approach to the recent dip in crude oil prices, when the price could be expected to return above zero, and the different resources needed to store different commodities.
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Rodney: Gabe, I always hear about this guy. Maybe you know him. The guy that lost the farm trading in the futures account?
Gabe: Oh, that guy.
Rodney: Have you met this guy? Yeah.
Gabe: I've met that guy. He's neighbors with the guy whose broker got him into ratio spreads.
Rodney: Yeah, exactly. Yeah. So man, the crude oil thing has me thinking back to also the big short squeeze in '95 or even the business end.
Gabe: No. That wasn't '95. I was a sophomore at Minooka Community High School.
Rodney: Okay. Yeah. Congrats. Yeah, just getting your license. What were you driving? What was your car of choice back then?
Gabe: You'll love this. So somebody wanted to sell us an old Crown Victoria for 300 bucks.
Gabe: And I worked all summer and had about 300 bucks, but instead of buying the car, I bought a computer.
Rodney: Oh, there you go. Yeah.
Gabe: I had friends that had cars. So we had... It was a Dodge Omni, man. So this Dodge Omni had an AM radio with one speaker. It was like a 1986 Omni, speaker in the middle of the dashboard. And then at some point along the way, my dad got in a light accident that dented the wheelwell. So anytime there was anybody in the backseat, it would just grind the back tire the whole time.
Rodney: Yeah. Right.
Gabe: Yeah. So that was what I drove most of the time was that fricking Omni. Yeah. But I did not have a car. Right? That was when my parents were kind enough to allow me the freedom to do that. But most of the time I relied on the kindness of my friends and otherwise I was nerding up on my computer.
Rodney: That's good. So while you were driving around in that Omni in the back, dragging it down, I bet that feels good when you're sitting in the backseat of an Omni and the tires are dragging.
Gabe: I bet it does too.
Rodney: Making noise. So back then, these farmers got in this situation where there was a glut of corn right in the country. So huge carry outs every year. And essentially it is called a normal market where the market's paying you to carry grain for some future timeframe. So, what they were seeing back then was carries from crop year to crop year. So every year we raise the next crop. There's a huge carryover. The market paid people to carry it over. Well, some guys got smart and said, hey, turns out if I call my broker up and sell December futures, right? Or so, whatever features and say I'm going to raise it 100,000 bushels of corn, I can go sell 100,000 bushels of corn. But in the past, if I just roll that to next year, back in the day it was probably $2.00, right? I can turn that $2.00 sale into $2.20, because the market's going to pay me to carry. So a smart guy here, I'm going to sell 500,000 bushels, right? For December.
Gabe: To be fair, you're growing 100,000, but you're going to sell for –
Rodney: Growing 100. Sell for 500, because I'm smart. Right?
Rodney: And the reason I'm smart is because there's a carry in the market. So I'm just going to continue to roll that crop out. So ultimately we get to July, let's say maybe September, I roll that from July to December again, and you can see my hand clearly over the Zoom here to get to the next crop here, and picking up 20 cents and boom, I just turned my $2.00 hedge into $2.20 or whatever, risk-free. Right?
Gabe: Yeah. Risk free. Yeah. There's no risk there.
Rodney: Yeah. So I honestly think in my area we had a big catastrophe with that where a bunch of guys lost a lot of money and getting into this situation. Inevitably what happened in July of 1995, old crop was looking really, really tight, raised higher and we saw the new crop contract kind of lower –
Gabe: Stay where it was.
Rodney: Inverted market. Yeah.
Rodney: And what happened was when these guys went to roll their head just forward, which they had to do, they were rolling into huge inverses, something like a dollar inverse. So they were taking these $2.20 corn contracts and turn them into maybe $1.20 if they had to roll. Right? And the problem is... So let's talk hedgers and speculators. At 100,000 bushel of December, say today, 2020, December 20 corn. If I'm selling 100% of my crop, I am very much a hedger, right?
Rodney: If I decide to sell 500,000 bushels in my crop, I am suddenly not a hedger anymore.
Gabe: You became a speculator 400,000 bushels ago.
Rodney: 400,000 bushels speculator. That's right. So I think around here there's always a name attached to it. It's always a different name. The guy that lost the farm plane in the futures market. But that guy, as long as you're hedging that, the worst case scenario, you just deliver that, right?
Rodney: Right? You know what you're in for. It's the second you go over that hedging into the speculating that now you're a speculator and you could get caught in this position similar to what I'm sure happened to a lot of these crude oil traders just yesterday. Do you think at 11:00 AM yesterday there was a crude oil trader that said, man, oil cannot go below $10, right?
Gabe: Not only that, I remember looking up at... So my TV is up to the side and I normally have CNBC on there all day. And I remember looking up and the headline on the bottom was, crude oil touches one scent. And I was like, no way. I was like, I wonder if it will get to zero? That just shows how little I knew about that.
Gabe: So, no. I'm sure there's a couple smart folks out there who thought it might be possible. But I feel like if I was sitting in front of my old broker job, if I was sitting there and I suddenly saw crude oil go negative, I would think, what's going on? Calling tech support, trying to figure out what's up.
Gabe: Those would be my reactions. You hit on this point earlier, that one of the things I've noticed crude's in, it's about to expire, right?
Gabe: And so in the corn markets when we get into that delivery window... So there's all kinds of things that we do as an industry to reduce the amount of exposure in that delivery window. And I haven't looked at crude oil elements in a long time, but the way most contracts work is for any given participant, they actually have a much smaller position you're allowed to have. Right? So for your average farmer, position limits don't mean anything, right? They're really there to stop hedge funds from having too big of a position. Commercials generally have exemptions, because they're buying and selling so much.
Gabe: But I guess the number of players involved is actually pretty small in that, and there may have been all a whole bunch of regulations that really restricted who could participate in that moment. If we bring it back to the markets that we deal with more frequently and you brought up hogs. And I think that's a great example, right? Because they're a big reason why the crude's a problem is you've got to put it somewhere and it's got to be in barrels. And I'm sure there's all kinds of regulations about how you have to take delivery and where you can keep it. Right? I can't put 40,000 barrels of crude in my backyard.
Rodney: I doubt we can just go pick up a barrel of oil.
Gabe: It seems like it's not good for anybody.
Gabe: But corn, I'm pretty sure you can pile if you want to.
Gabe: There's nothing stopping you there. In hogs though, hogs are a great example because there is a bunch of regs around that, right? You have to be able to deal with waste and the hog barns and it takes resources to do that. You can't just pour some concrete out and put a bunch of hogs on it.
Rodney: Yeah. Well in the bigger picture with hogs, let's say we could take a barrel of oil and shove it in the garage or this New York City apartment, your only real cost with that is interest, right?
Rodney: Where hogs is a totally different deal. Every day that hog is on your farm.
Gabe: You've got to feed it.
Rodney: You're disposing waste and you're feeding it. And that there's a cost to that.
Rodney: It's more of a depreciating value.
Gabe: So I don't think we should go through the painful exercise of figuring out how we would get hogs to negative prices, but I do think it's a helpful thing to think about, like where is this relevant? Where isn't it? So negative prices seem a lot less relevant in grain itself. Grain oil sees itself, but does seem relevant in its offsets, right? So obviously ethanol, right? Would presumably... I haven't even gone looking at what ethanol prices are doing right now in that.
Rodney: So I didn't see prices on ethanol, but I saw this morning that they're figuring usage right now or production right now, production, sorry, is about half of capacity.
Gabe: Okay. So about half the ground is shut?
Rodney: Yup. So what I love about the futures market is it shows you what the market thinks, right? So we've got negative right now, we've got... So last night when I looked, it was negative 35 for the May contract and positive 22, I think for the June or July. I think it is June where it's July for corn.
Gabe: It's definitely June. Yeah.
Gabe: So crude's every month.
Rodney: Got you, but what was interesting, it was all the way up to $40 for next May. So what that tells me is the market, at least the oil, the crude oil market has priced in some positivity if only lukewarm. Right? But some positivity to a recovery because they anticipate that crude oil in June of next year is worth $40. Right? So it was worth more than it is now. So that to me, infers increased demand, probably less than, less supply I would think. Gabe is looking at me like, that's a bold statement for –
Gabe: No, no, no. So it all comes out, there's two big questions, right? So one is obviously, when does the economy start to turn back on? Right? So when does consumption return or when does it even start to return? Not when does it return, but when does it start to show back up?
Gabe: And then the other one is, do you think the producers... So there's an agreement, right? Starting May one to reduce oil production.
Gabe: Does this cause them to take even more significant steps? And that's a whole nother set of game theory that again, I don't know that that's a great place for us to spend time. But it's interesting, because farmers run through, I would say a similar version of that game theory every year when they decide what to plant.
Gabe: Just, they each have a smaller planet than say, Saudi Arabia does.
Rodney: Yeah. And it might be worth pointing out here that this is not primarily a COVID-19 story, right? This is partly a spat between Russia and Saudi Arabia. This is definitely partly COVID. This is partly just less usage, which is mostly a result of COVID.
Gabe: COVID, yup.
Rodney: Right, but it's not just a COVID story for sure.
Gabe: Yeah. It's tough to know the counterfactual of if COVID wasn't happening, would we have been in the scenario? It feels like probably not. Right?
Rodney: Right. I agree. I agree.
Gabe: So thanks COVID for teaching us yet another lesson.
Rodney: Man, oh man. Lessons. Well, hey, the beauty of the grain business is I learn a lesson every year.
Gabe: Every day.
Rodney: For sure. For sure every year.