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Question about commodities and the future

1524 Views 46 Replies 14 Participants Last post by  menollyrj
I have been wondering how the price of commodity futures affect the price of the groceries we buy. I just saw that orange juice and pork belly futures are way up does that mean that orange juice and ham at the grocery store are going up in price? And if so how long does it take once the future prices go up for it to affect the prices at walmart? Any smart people out there want to help me out?:)
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Lets say I'm running a sawmill and produce 10,000bft each day. There are 20 guys buying standing timber and selling logs to me. I pay $100 a cord for logs. We are having a wet fall season slowing cutting and hauling, some guys have gone hunting. I start running low on logs but have made deals to sell 500,000bft of lumber by the end of the year. I have signed contracts agreeing to sell at a set price. To increase the delivery of logs, to meet my needs, I offer $200 per cord. That jump increases my supply, but I can't make money if my finished product price is locked in, but my input costs double.
So, the next year, I try to get a whole year's worrth of wood bought during the summer, but the bank won't give me such a large amount of working capital. I can't keep orders filled if I don't know what the logs are going to cost me. So I agree to buy a months worth of logs from the 12 lowest bidders, to be delivered and paid for on the first of the month. Now I don't have to worry about weather or their hunting. With a set price locked in, I can set the price of my lumber on into the future. If one of the guys that holds a month's contract has a breakdown, he may have to get logs from someone else and he may have to pay a lot more for those logs. But that's his worry, not mine. I'm willing to pay a bit more for logs on a future contract than what I was paying before, but I've eliminated the ups and downs in my availability and price. The guys selling logs can get loans on equipment based on contracts they have sold.

In the hay example, what do you do when the guy you spoke with last year tells you that half his hay got rained on and a hay broker offered him $3.00 a bale for the rest of his crop? Makes you wish that last year you'd had a solid agreement on this year's hay. You can go right on with your cozy "understanding", but all to often we eventually get stung. We can't always "lock in " a price a year in advance, but if you know how many bales and at what price, the supplier can be sure of a market for his hay crop, everyone wins.
If I thought there would be a shortage of hay in your area, I could agree to buy up 10,000 bales for $3.00, next year. Then the farmers would see an up coming shortage in supply and only sell this years hay for $3.00, up from the normal $2.00. Buyers, like yourself, would move to buy hay ahead of time next year. This "stock-piling" creates an even bigger shortage. People, unable to buy hay at $3.00 a bale, start running adds looking for hay for next year. I offer ten lots of 1000 bales at $4000 each lot. Once I've got it sold, I'm out of it. I haven't had to stack one wagon, but I've made $10,000. The farmer didn't make any extra money on this deal, the fertilizer company didn't make anything extra, the trucking company gets the same. You add your feed cost increases into the cost you charge for pork. You add in a bit more so you can start buying your own hay equipment. Then the pork buyer complains about how much money you and the hay farmer are profitting on their need for pork. That's what just happened in the oil market.
Hilery Clinton had a Futures Company "invest" $10,000 in cattle futures. The price goes up and down every day. They managed to sell hers when the price was up and buy them back when the price was down, over and over. In a years time, she had $100,000. Simply amazing woman.
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Clovis thinks elimination of futures contracts would be good for the consumer. I disagree. Without futures contracts, many farmers wouldn't dare plant a crop that didn't have a buyer or value locked in. If they held back, even a little, that would create a shortage, driving up the price and causing food shortages. Soon we'd have a whip-saw effect on all products.
If I can lock in a price for May 2009 corn, I know how much I'll need to get for my hogs in September 2009. If I can't lock in a price for my hogs high enough to make a profit then I won't breed my sows, I'll send them to slaughter.
Most of the futures contracts are held by those directly involved in the business. It tends to stimulate or reduce supply ahead of time, evening out the highs and lows.
Oil refineries buy oild futures, insuring a steady supply well into the future. Some investors/speculators thought the unrest in the Middle East would cut supply in the future, driving the price way beyond prersent prices for a barrel of oil. So they bought oil futures contracts for oil in the future. Oil companies had to continue to buy their oil futures contracts, but there wasn't enough oil in the future to fill those futures contracts. This increased the demand for oil in the future. Investors/speculators saw the price jump and bought even more oil future contracts. This drove the price way up. It was good business to buy oil at the well for $60 and sell on the open market for $200. Oil futures were bid up higher and higher as investors/speculators continued to plow more money into the oil futures. The guy that owned the well didn't profit and the refineries simply tacked on their slim profit. But 3% of $200 is a whole lot more than 3% of $60, so they neted much greater profits, too.
Some investors/speculators got caught when the demand for oil slowed, Saudis increased production, and the futures they'd bought for $120 was selling for $60.
As we shoot from the hip, we think that all speculation of comodities should be stopped. But the reality is that is stabalizes production and demand. The perceived oil shortage created a profit potential to the investor/speculator, just as we created a canning jar lid shortage in the late 1970s. The supply was there and the actual demand was level. But when we heard that there wouldn't be enough, we began to stock up. All across the land, folks were stocking up, creating a shortage. No matter the price, buy all you can find. I'll bet you've still got some of those lids in your pantry.
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Buying contracts in the commodities market is a complex issue by itself. Mixing it up with Investment Firms that manage Retirement Plans is a whole new can of worms. Throwing in a Government bail-out of Financial Institutions that loaned out mortgage money to people that can't pay is a new kettle of fish, altogether. While these three topics have connecting pieces, they are, for the most part, seperate issues.
If I have a gut feeling that "Tickle Me Elmo" will be the hottest toy this Christmas, I will buy stock in the company that makes that toy. If I'm correct, I'll make a lot of money without actually owning the doll or helping with it's assembly. Am I a smart investor or an evil blood-sucker?
If I have a gut feeling that the world demand for corn will exceed the supply and I can buy a contract for 10000 bushels of corn in Aug 2009 for $3.00 a bushel, I'll buy it. If corn pushes to $4.00 a bushel by then , I make $10000. by selling my corn at market price. I never weeded a row. I never shelled an ear. Am I a smart investor or an evil blood-sucker?
If I am managing retirement funds for a group of people, I can put their money in a bank CD and get them a return on their investment of under 3%. If my company gets a chance to buy up a bunch of home mortgages, all payments up to date, earning 6%, can you fault me when people suddenly stop making their payments? Who could have seen that the value of homes would stop and then reverse its 60 year steady rise?
Henry Ford prevented suppliers from being able to control his profits. He bought Rubber tree plantations, iron mines, hardwood forests, etc. He built villages at each of these places so he could control the housing costs to his employees,too. Today, you can hedge your costs of inputs easier by purchasing futures contracts. You put the responsibility onto the back of the person that sold you the contract. If I buy 1000 pork bellies for August 2009, I can be assured that my Haypoint Baked Beans can keep that hunk of bacon, without cutting into my profits. However, if McDonalds starts putting three strips of bacon on their McMuffin, instead of just two, the price of pork bellies would jump and the seller of my contract might have to buy pork bellies at a price above what he sold them to me. That is how people lose in the Futures Market. Good for me, too bad for him.

World hunger is another complex important topic. Again, it is a seperate issue from the above listed issues, with a few connecting parts.
If I only grow enough corn to satisfy my futures contracts, with a few bins extra, just in case there is a spike in price ( to put it another way, just in case other farmers lose their crop), I can stay in business. That means maintain my land and equipment, plus pay for my inputs: seed, fertilizer, fuel, etc, with enough left over to pay my mortgage on the land I farm and give me a fair wage.
I can't sell my corn for $2.00 a bushel and continue to farm. Many third world countries cannot afford to buy corn at a price that I can afford to sell it. I continue to farm, they starve. If I sell for what they can afford, I get driven out of business by debt. Is there a more fair way to do it?
If the US sends food and supplies to 10,000,000 starving people in some third world arid place with infertile soil, we can stop hunger for 10,000,000. In ten years, we'll have 60,000,000 starving people in that country. What then? At some point we have to realize that our efforts to help, just brings more suffering later on.
If you want to feed the hungry in another country, there are boxes down at the grocery store. Get some, fill them up and mail it to them. Don't expect the taxpayers (middle class) to provide for it. Foreign aid is the act of taking money from the poor people of a rich country and giving it to the rich people of a poor country. Wish it weren't so, but 'tis.
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Let me try to explain it in a simplified way. An August 2009 futures contract is an agreement to provide a set product and a set quanity in August 2009.

Here is an example:
I have 1000 cows that will be ready for the market next August. I'm hoping the market will give me $1.00 a pound for them. I need .80 just to break even. I get an offer to buy 500 of my cows, or about 600,000 pounds for .90 per pound next August (futures contract). So I enter into a futures contract for 600,000 pounds of cattle at .90 a pound next August.

If we have a wet spring and a dry summer, corn prices will jump up and more farmers may have to reduce their herd size, flooding the market in August. Cattle prices could drop below .80. I'm protected because I have a buyer that is giving me .90 in August. If this buyer isn't a slaughter house but just an investor, he will have to sell that contract for less than he is paying me, taking a big loss.

But, if during the next few months, Japan and Korea open up to US beef imports, increasing demand, the price next August could reach $1.20 a pound. The holder of my futures contract can sell my futures contract for 500 cows and realize a $180,000 profit.
I still have 500 cows to sell at current market prices and the .90 I got in that contract still earns a profit for me, so all is good.

I don't have to actually own the commodity to sell a futures contract. If I think the price of corn will be way down in October 2009, I can sell an October 2009 contract for 1000 bu. of corn at $4.00 a bu. Between now and then, I watch the price trends. When they are at what I believe is their lowest point, I buy a contract for 1000 bu of corn at, say $3.80 a bu. for October 2009. I make a profit of $200 and haven't shucked one ear.You may ask why would anyone buy corn now for delivery in October 2009, when the price may go down. Businesses need to lock in their supplies far in advance. This process tends to level out the supply and demand, avoiding oversupply and shortages.

The Government bail out is complex. The Government pushed banks into making home mortgages to poor folk in the 1980s. Just remember what political party benifits by helping the poor folk. A home has been the fastest growing asset for most American families. Why not let the poor folk in on it? The Government provided the money, loans at prime. Banks offered very low interest rates to get them started, with the rates to go up in a few years. Poor folk went to Banks and asked about getting a loan to buy a house. Mortgages seldom go into default, so as long as the poor folk could buy food, clothes and a bottle of Royal Crown once in awhile and still cover a mortgage they got their loan. They figured if those money experts thought they could afford it, must be they could.
Then the economy stumbled. People lost their jobs. Pressure on new home construction became a vaccum. People with no reserve (most of America) began to dump their homes onto the Realestate market and then onto the mortgage holders (Banks).
Along the way, Banks sold their mortgages to other Banks. Then those Banks sold a collection of these mortgages to investment furms. These Investment firms took people's savings and bought stocks, Mutual Funds, gold, commercial loans and home mortgages. It is their sole job to spent (invest) the money in ways that will make it grow. It does involve risk and they goofed. Millions of people are losing their retirement savings. Millions of poor folk are losing their homes. I haven't enough fingers to point who is to blame.

Let the Banks fail? This further stalls the economy because they can't make the loans business needs to expand or maintain inventory. People can't buy vehicles if they can't get a loan. Without mortgages home prices will continue to free fall.
Let the Investment Firms fail? Plan on having your folks move in with you, then. Their 401K just blew away.

Let the poor folk lose their homes? We are either going to see a few million more street people or we'll be paying their rent. If we pay their rent, forever, we might as well bail them out now and get them off our backs later.
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