There are no clear, singular solutions to bolstering cash fed cattle price discovery, but some industry participants are taking definitive steps in that direction.
Perhaps the most visible is the Fed Cattle Exchange, an online fed cattle auction developed by Superior Livestock Auction (SLA). The notion is straightforward: Increase the weekly volume of fed cattle sold in the cash market by giving buyers a chance to bid on pens of cattle consigned by feedlots — all on the internet.
This has been tried before, of course, but cash trade has never been as sparse.
“It’s as much about timing and history as anything,” believes Danny Jones, SLA president. “The number of cattle traded in the cash market is so low, and there hasn’t been a good, representative sample in terms of volume and quality. A lot of people are interested in changing that. We definitely believe in this and think it’s needed.”
SLA hosted the first Fed Cattle Exchange sale at the end of May. After four weekly sales, SLA halted the sales to work on some technical issues. By the end of July, as this article was being written, Jones says they were close to bringing the auction back on line.
Those first few sales suggest plenty of promise, though.
“We’ve received good cooperation from the industry,” Jones says. “There was good participation from both sides, buyers and sellers.” He adds that lots more feedlots registered to consign cattle than actually did so in those first auctions, suggesting that cattle feeders want to be ready to participate.
Tackling futures market volatility
Though less visible, the working group formed by the CME Group (CME) and the National Cattlemen’s Beef Association (NCBA) continues to assess volatility in cattle futures markets.
Keep in mind that effective futures markets contribute to cash price discovery of the underlying commodity. Conversely, futures markets suffer in the absence of an effective cash market.
In January, the NCBA Marketing Committee sent a letter to Terry Duffy, CME Group chairman and president, expressing concerns about the effectiveness of cattle futures markets. Duffy attended the committee’s meeting in February and pledged his organization’s commitment to finding solutions.
“Our relationship with CME Group is the strongest it has been in the 12 years I’ve been here,” says Colin Woodall, NCBA vice president of government affairs.
Topics of concern addressed to Duffy and the CME included overall price volatility and the potential contribution of high-frequency trading (HFT) to price volatility.
Through HFT, computers make, modify and cancel trades in fractions of a second. There is no clear legal definition of HFT, but some consider it a subset of algorithmic trading. These methodologies are not unique to agricultural commodities or derivative markets like futures. Widespread use began in equity markets years ago.
HFT proponents cite advantages like lower transaction costs, increased precision in positioning and increased liquidity.
Criticism of HFT includes allegations that the practice can increase volatility and create the illusion of more liquidity than actually exists, according to the congressional report HFT Trading: Background, Concerns and Regulatory Developments. Systems like CME’s Messaging Efficiency Program (MEP) are designed to help thwart that.
At the very least, plenty of folks say HFT at least contributed to the Dow Jones "Flash Crash" of 2010, when that financial index dropped 1,000 points in a few minutes.
According to ongoing analysis by the CME Group since January, manual point-and-click traders led the market moves (live cattle) on limit up and down days. Not the HFT or algorithmic traders.
CME Group also made several changes in how cattle futures and options are traded on its exchange. Among the changes the CME Group made in how cattle futures and options are traded, as detailed in the CME FAQ “Recent CME Cattle Market Volatility,” are:
- Reduced daily trading hours (Feb. 29) to align with the period of greatest liquidity. Roughly 87% of trading occurred between 8:30 a.m. and 1:30 p.m. Central time last year, according to the CME FAQ.
- Added livestock products to its Messaging Efficiency Program (MEP) on Feb. 1. Without coasting too far into the weeds, a message is sent by buyers and sellers to submit, modify and cancel orders through the CME Group’s electronic trading platform. The program monitors the ratio of messages to orders actually filled. Between January and April this year, the ratio of messages to orders filled in live cattle decreased by 15%, according to CME.
- Implemented a pre-open period (June 6) for customers to enter, cancel and modify orders for livestock futures and options.
In August, the CME Group adopted a $1.50 per cwt discount for the October live cattle contract for cattle tendered to Worthing, S.D., in an effort to bring cash and futures prices into convergence across the delivery area. It also increased the par quality grades for Choice and Select to 60% and 40%, respectively, effective with the October 2017 contract.
According to Woodall, the CME Group is also seeking approval from the Commodity Futures Trading Commission (CFTC) for a trial circuit-breaker program, by which futures trade would cease for 2 minutes if prices move $1.50 or more in either direction within a half-hour.
Woodall explains NCBA continues to expand the working group to ensure there is adequate representation by sector and regionally.
“There is still lots of frustration, and more questions than answers,” Woodall said following the NCBA Marketing Committee’s meeting in June.
Currently, he says the working group is focused on getting data from CME, something that requires going through the CFTC because of legalities that tie the CME’s hands.
“It’s hard to determine whether a proposed action would be positive in terms of leveling the playing field for the true hedger if we don’t know who is participating,” Woodall explains. He’s not talking about knowing the identity of individuals or individual firms but the type, such as manual trading or HFT.
Along with evaluating potential futures contract modifications, Woodall says the working group will consider the conclusions and suggestions resulting from the Price Discovery Research Project (PDRP) conducted for NCBA by Stephen Koontz, agricultural economist at Colorado State University.
That brings us full circle to where this BEEF series began.
The cash fed cattle market is central to — some would argue it is the beginning of — price discovery in other markets, such as feeder cattle and beef. It’s also key to the effectiveness of risk management tools like the futures market.
“Volume will not return to cash markets. There are strong incentives for individuals to market fed cattle through methods other than negotiated cash trade,” Koontz explains in the PDRP executive summary. “But the thinning cash market problem will not solve itself. Action by the industry is needed.”
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