Funny money affects grain too

The party may be over for high grain futures prices – due to the wider economic crisis, which may see some managed funds lessen their exposure to all markets, including the soft commodities market.

ProFarmer managing director Richard Koch is warning farmers to brace themselves for the possibility of index funds to exit the sector.

If this happens, it will have a sharp, negative impact on the grains sector, in spite of the solid fundamentals surrounding the industry.

“Should the current uncertainty in global financial markets lead to a sharp and significant redemption of investments from Index funds, commodity markets will be unable to escape being caught in the net of the financial market crisis,” he said.

It could have a monster impact on commodities such as wheat.

The large capital inflow through the latter half of 2007 and early 2008 is notable.

It coincided with a large rise in CBOT wheat futures; however, since March, the Index fund position has fallen back to levels more akin to those of 2006 and 2007 and the wheat price has

contracted.

“The major concern is that Index funds still hold some 47pc of all open interest in wheat.

“Should the Index funds decide to exit their positions en masse, wheat futures would take an enormous tumble,” says Mr Koch.

However, Mr Koch said this was not a fait accompli, and that if the wider market stabilised, the impact on grain futures would be minimised.

The extent of the exposure to the market crisis is tied up to the large scale investment in soft commodities by the index funds over the past four years.

Mr Koch estimated US$200-250b flowed into commodities from these index funds alone, in that time.

This investment has been responsible for inflating the furious growth in grain futures to previously unimaginable levels – but the industry will be anxiously watching to see whether a large scale exit from fund positions will see an equally dramatic drop.

He said the panic surrounding the collapse of major US investment banks such as Lehman Brothers has seen money now flowing out of the index funds, and therefore out of grain futures, as many of the big gains of the past few years have been turned into large losses in the past few months.

The big question for the grains industry now is what will happen on global financial markets generally, over the coming months – as the index fund makes up a large part of the liquidity of the major grain trading exchanges.

A recent US Commodities Futures Trading Commission report pegged the notional value of Index fund trading at US$146b by the end of December 2007 and as high as US$200b by end of June 2008.

Mr Koch said this significant inflow through the first part of 2008 was a major reason for the jump in commodity prices.

All of this more recent investment – since the start of 2008 (estimated at some US$54b)– is facing a negative return.

He said the big concern here is that with the rising cost of credit and more cautious lending profiles, index funds may redeem portions of their investments, both as risk management and to raise liquidity.

““There will be investors in index funds who may be forced to redeem their investments in order to shore-up their liquidity positions,” explained Mr Koch.

“The costs of funds when borrowing is now extremely high in some markets and liquidating assets may be the preferred alternative,” Mr Koch said.