Role of Hedgers and Speculators in the Agricultural Market
The commodities market plays a pivotal role in the agricultural economy, providing a platform for participants to manage risk, discover prices, and facilitate trade. Two key players in this market are hedgers and speculators, and each serves a distinct role. In this interview, we talked to Doug Christie, an ex-Cargill agribusiness executive and author of the newsletter Agricultural Commodities Focus, for a deep dive on the differences between these players and their importance for the market.
Can you explain the differences between hedgers and speculators?
Christie: There are two broad groups of market participants when we look at the ag market. One would be hedgers or the people that are physically involved in markets based on their underlying business. And a second group that you might call speculators, investors or financial participants who don't have a physical stake in the market, but are still taking actions in the futures market looking for price volatility and letting price actions drive their participation in the market.
So those are two different groups with really different orientations in how they approach markets.
In the case of hedgers, their action in the market is usually driven by something that's going on in their physical business. And maybe the most fundamental example of that would be a farmer who's growing a crop in his field knows that he needs to sell that crop in order to turn it into cash.
A farm has price risk for the crop that's growing in his field. One way that he can manage that price risk is to take an action in the futures market to offset the price risk that he has from growing a crop. One example of that would be that while the crop is growing and it's not yet ready to sell, he could sell futures in anticipation of harvesting his crop. And that's causing him to take an action in the market because of the physical underlying commodity flow that he's got.
Another example of that might be when a large grain grading company makes a sale of corn to China. So they've sold a big physical slug of corn in the market, they need to come back into the futures market and hedge that risk. So they'll take actions to buy futures contracts to manage their position or offset the risk of having sold a physical cargo. In the case of hedgers, that can at times lead to big orders coming into the market or lots of activity based on a physical transaction that maybe other market participants didn't see or didn't have access to.
And so that can create some volatility and that can sometimes be a source of surprise or reaction in the market when you see a big flow of orders coming in and you don't really understand why. A hedger may have the advantage of knowing, "I've made a physical sale to China, I know I need to come into the futures market." So they understand that cause and effect better.
On the other hand, speculators who might be looking at technical signals or flows of funds will come in with a big buy or sell order, and take an action based on a trigger price being hit or a certain target level being reached. You'll see a big order flow driven by hitting that target level.
A speculator will look at the market and say, "I think the current price of corn is too high because there's lots of production coming. So I want to take an action to sell futures thinking that the price is going to go down in the time going forward."
And to people that are physical players in the market, they may look at that and not see the significance of that particular price or the significance of that order flow and be questioning why there's a big market reaction.
So hedgers and financial players can balance each other in some ways in that each has their own unique view to the market, and each can be a driver of order flow that moves prices, and it's not always transparent to others in the market what might be motivating that. It's one of the things that keeps commodity trading volatile and interesting, is that it's not always possible to know what the underlying source for a trade is when you see order flow coming into a futures market.
That almost sounds like gambling. How do prices reflect the dynamics?
Christie: This flow between hedgers and speculators or different sources for orders coming into a market, one of the dynamics that that illustrates about markets is as a trader or market participant, you always have to be asking, "Is the price reflecting something that has already happened or something that's going to happen?"
Let's say we see a big order flow come in and a lot of buying in the futures market. Does that mean it's because people anticipate a big market buyer like China might be coming in to buy corn or soybeans from the US, or does it mean that a big market participant like China has already bought physical grain and we've seen hedges come into the market and that's what's driving the market?
So it's always kind of a question of, "Is the market pricing what has just happened or what's anticipated to happen?" And that's one of the dynamics that makes commodities very, very interesting.
On the date of publication, Hedder did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.