High and Dry : Drought-Driven Boom in Commodities Whets Traders’ Appetites

The Midwest drought is scorching farmers’ spirits and crops, but it is bringing a flood of cheer to traders and officials at the nation’s commodity futures markets.

Thanks in part to sharply rising prices on key agricultural products, the Chicago futures exchanges are taking some of the spotlight these days away from their more glamorous stock exchange rivals in New York.

Futures trading volume has been the busiest since last October’s stock market crash, with the granddaddy of all futures exchanges, the Chicago Board of Trade, threatening to set an all-time record for monthly activity. That, in turn, is boosting prices of memberships on the exchanges and leading to increased hiring of brokers, traders and other floor personnel.

Luring Investors

“We’re busier than hell,” says Roy Huckabay, a trader for Linnco Futures in Chicago, which has added more employees than normal this time of year.

The activity also has lured more individual investors into the futures fray. They are either trying their luck by investing directly in commodity futures contracts or handing their money to professionally managed commodity funds. (A futures contract is an agreement to buy or sell a specific quantity of a commodity or financial instrument at a set price on a specific day in the future.)

“We’ve had a lot more interest” from individual investors, says Tom Lane, a vice president for commodity marketing at Merrill Lynch in New York.

New commodity funds “are selling out rather quickly,” says Leon Rose, publisher of Managed Account Reports, a Columbia, Md., newsletter that tracks those funds. Recent new commodity fund offerings by Merrill Lynch, Shearson Lehman Hutton and Prudential-Bache sold out quickly, he notes.

“A lot of people are recognizing the value of putting a portion of their money in the futures market” as a hedge against stocks, Rose says.

Extreme volatility has a lot to do with keeping up the interest. Tuesday was no exception, as drought fears drove corn futures prices on the CBOT up their daily limit for the sixth consecutive day. Soybean futures also rose sharply, but wheat futures retreated.

Record-Setting Pace

Nowhere has the increased interest in agricultural commodities been more noticeable than at the CBOT, the world’s largest futures exchange and the home of principal contracts in soybeans, corn and wheat--the crops most affected by the drought.

Through Monday, this month’s total volume for all CBOT futures was 10.14 million contracts, setting a pace that would break the previous record of 14.77 million contracts set last October. Then, the record came largely from volatile stock and bond markets, which sparked heavy trading in the CBOT’s popular Treasury bond futures contract.

Trading at the CBOT in commodity options--which provide a somewhat less risky alternative to futures--has already been setting records for weekly volume.

About 1,982 workers--ranging from traders to brokers to runners to clerks--are plying their trade at the agricultural floor of the CBOT, up 26% from a year ago. The volume of visitors to the exchange is up, as are inquiries from the news media.

“The pits are full. Six months ago, the soybean pit was only two-thirds full and the options pits were pretty thin,” says Mark Prout, a senior editor in the CBOT’s public relations department.

The intense activity in the grain and soybean pits is drawing traders from other pits where volume has not been so hectic. One trader, who had been trading in stock-index futures at the Chicago Mercantile Exchange, now is trading in soybean options at the CBOT, Prout says. Other bond traders also have moved over to the agricultural markets.

Seat Prices Rising

As a result, a seat, or membership, on the CBOT sold Monday for $465,000, up from $410,000 a week ago and the post-crash low of $333,000 last Oct. 23. The record of $550,000, paid for a seat last Aug. 31, seems attainable soon.

Prices of seats on the Chicago Merc--where livestock futures are traded--and the CBOT’s sister exchange, the Chicago Board Options Exchange, also are rising.

But the greater activity resulting from increased volatility also has its cost: higher risk of trading losses.

With prices on contracts in soybeans and grains rising quickly to their daily limits for several straight days--at which point trading stops for each day--it has increased the danger that a holder of a contract may not be able to unload the contract quickly. With prices at such high levels now, contracts could easily go down their daily limits for several days in a row, too.

“It could be four to five days before you can get out of a position,” says trader Huckabay. Accordingly, he says, an investor could easily lose twice his investment in a soybeans contract before he can get out.

That prompted the CBOT on Tuesday to raise its margin requirements--the amount of the down payment an investor must make to buy a contract. It now takes $5,250 to acquire the CBOT soybean contract for 5,000 bushels, up from $2,500.

The increased volume also has increased the risk of incorrect or botched trades due to human error--always a potential problem in the “open outcry” system of futures pits, where traders shout aloud their buy and sell orders.

As a result, some firms, such as Huckabay’s, have added extra people to double- and triple-check orders.

“Everybody’s got to be super careful,” says David Keefe, a vice president and trader at Staley Commodities in Chicago. With the higher risk, “we’ve got to be more alert and not make mistakes that would be extremely costly.”

Fortunately, the risk from volatility is not expected to translate into significantly higher prices for consumers on bread and other food products. Raw grains represent only a fraction--less than 10%--of the price that consumers pay for food at the supermarket.

And an abundant surplus of U.S. grain stocks should prevent dramatic rises in food prices despite the drought, according to a special report released Tuesday by the U.S. Department of Agriculture.