It’s been said that the investment funds, also known as outside investors or the “smart money” have enough cash to buy up all U.S. corn, soybean, and wheat production in any given year.
Knowing that, it’s widely believed that all traders in the commodities sector, including farmers, would benefit from knowing the market involvement of these major players.
For many years, traders have tracked the positions of those major market participants in the futures and options markets through the Commitments of Traders Report (COT).
The COT report is released each Friday afternoon by the Commodity Futures Trading Commission (CFTC).
The CFTC is an independent agency of the U.S. government created in 1974, which regulates the U.S. derivatives markets, including futures, swaps, and certain kinds of options.
The report provides positions held by commercial traders, or those using futures to hedge their physical assets; noncommercial traders, or money managers (also called large speculators); and nonreportables, or small speculators.
A net-long position indicates more traders are betting on higher prices, while a net-short position means more are betting futures will decline.
As of Friday, the COT report shows that funds continued to buy corn and soybeans. Funds bought 15,000 contracts of corn and are now long 34,000 contracts. Funds bought 12,000 contracts of soybeans and are now long 174,000 contracts of soybeans. For wheat, they are now 27,000 contracts short, when you combine all three exchanges.
Historically speaking
The COT report hasn’t always been a weekly reading of the smart money’s positions. The report used to be a monthly collection of outside investors’ positions, then it was released biweekly, and now weekly.
Over the years, as more people got into the market and investors considered commodities as an asset class, the desire to get this information more frequently has gone up.
These positions can change significantly, according to Greg Lumsden, Cargill MarketGuide’s product line leader.
“In the last 10 to 15 years, when ethanol came online and market volatility jumped higher, you really saw more people take an interest in the COT Report. A lot of the information was about commercial activity in the market. But now, with the amount of money thrown at these farm markets, there is a heightened sensitivity to the COT Report,” Lumsden says.
Report Respect
While the COT Report has its critics, Lumsden sees it as a marketing tool that should be used by farmers.
“August was a good example. Yes, the fundamentals were there to help the big corn price move. Farmers will likely say, ‘Wow, if the market moves 40¢ already, I’m getting bullish and I see this thing going straight to $4.00 per bushel.’”
What was really happening was a lot of funds wanted out of their short positions. There is a big difference between a classic bull market and a short-covering rally. By following COT data, farmers could take advantage of the short rally sparked by the funds, Lumsden says.
“When the market gets frothy and the bottom falls out, farmers should understand that it’s likely the funds are liquidating their long positions. The Commitments of Traders report is not to be taken as gospel, but it should be put into your grain marketing toolbox,” Lumsden says.
Arlan Suderman, chief commodities economist, StoneX Group Inc., agrees that the COT Report has great value in offering transparency to the marketplace.
“Market participants get to know who the other participants are, not by name or firm, but the sector players. For instance, it tells you how heavy the commercial positions are vs. the producers’ positions. Also, the report tells you the positions of the hedge funds vs. the index funds. This is important because all of those groups trade the market differently,” Suderman says.
Knowing the size of the other participants’ positions can tell you, as a trader, what your vulnerabilities are and what risks that you need to mitigate, Suderman says.
Delayed Data Criticism
The COT report is not without its critics.
There is frustration amongst traders that the COT data is not released on a daily basis.
“We’re in a stage of daily electronic reporting that is even overshadowed by electronic and algorithmic trading that happens in one-thousandth of a second, yet this COT data only comes out on a weekly basis vs. daily,” Suderman says. So, when these numbers come out on Friday, they are delayed.”
Suderman believes that the CFTC should be utilizing its budget to fund the release of COT data on a daily basis.
“How valuable is the data when a major market event happens and you don’t find out the impact on the players of the market for days later,” Suderman says.
Farmers’ Use of COT
While the COT report is seen as a valuable grain marketing tool, it’s believed that a lot of farmers underutilize it.
“My experience is that some farmers use it, but most do not,” Suderman says. There are some who understand its value, but most farmers don’t take the time to study its implications.”
Suderman added, "I think that would improve if the report provided more timely information.”
The StoneX Group provides its farmer-customers with daily estimates of the funds’ market position changes.
“But with electronic trading, it’s more difficult to make those daily adjustments than it was when trading was conducted in the open pit of the trading floor,” Suderman says.
Correlation with Corn
While the COT Report is not a foolproof measure of market direction, it does provide some correlation with the direction of the corn market, Lumsden says.
“For instance, in the month of August, you could see where the funds had a very large short position; the market was at seasonal lows, indicating that the market felt overdone. In addition, there were key technical support levels in place. When you combine all of these, it gave you the bias that a bottom was forming in the market.
“We felt like if we get a spark in the market, the funds could begin to unwind their short positions or get closer to even, we could see some upside. And that is exactly what happened.”
In August, fundamental factors that concerned investors also had a hand in getting the funds to trim their short positions in the farm markets. Along with crop weather problems lowering yield estimates, demand ramped up.
At that point, investors started taking profits and exiting their short positions, and the markets moved 40¢ off their lows.
It’s important to point out the correlation differences that index funds and hedge funds have to the corn and soybean markets.
Index funds that are trading commodities, only attempting to diversify their portfolios, don’t carry a very big correlation to the farm markets as hedge funds, Suderman says.
That said, index funds are starting to put agricultural commodities back into their portfolios as an inflation hedge, Suderman says.
While index funds will hold onto their positions for months or up to a year, hedge funds will change positions based on the current market trend.
“Hedge funds are changing their positions with much more frequency and quickness, many of them tied to algorithmic computers.
“So the positions they have and the direction they are going in have a big impact on the markets,” Suderman says.
Fall Fund Activity
Looking forward, it’s important to split what the funds normally do in the fall and what they are expected to do.
This fall and winter, the funds are expected to be countercyclical in their trading.
Normally, the funds see the months of August, September, and October as weak market months. If the U.S. crop production looks favorable, funds will build a large short position and sit in it. They look to take advantage, through short positions, of farmers selling their crops and the farmers’ hedge pressure.
This year, the funds may alter their fall and end-of-year market positions, Lumsden says.
“All summer, we had thoughts of record-high yields, demand destruction thoughts because of the coronavirus, all creating a bearish sentiment. But all of the sudden, demand for corn and soybeans picked up in late summer, people started to question production, and suddenly the carryout is looking a lot more interesting,” Lumsden says.
As a result, the funds have gone from record short positions to getting even the markets.
“We anticipate the funds to getting long, following their shift away from record shorts. I’d be shocked if we go into October, November, and December, if they didn’t keep exiting short positions and convert to getting long these markets,” Lumsden says.
The index funds are not going to change their positions a lot, just based on the supply/demand fundamentals. That category of investors will only change if they see something in the macroeconomics.
Because of Congressional stimulus packages responding to the coronavirus pandemic, trillions of dollars have been pumped into the U.S. economy.
“There are a lot of people with government money in their pockets. They are looking to trade and get rich,” Suderman says. “Combine that fact with a falling U.S. dollar, and it suggests that we are entering into an era of inflation. Money is floating from asset class to asset class trying to find which one has a story.”
Suderman added, “The asset class that gets the investment money doesn’t have to have strong fundamentals, it just has to have strengthening fundamentals. Grain and oilseeds are well supplied but they have strengthening fundamentals with lower crop estimates and stronger demand.”
Money Flow
Corn prices at the farm can change, depending on whether the funds are bullish the commodity sector or bearish the commodity sector, Suderman says.
“It could be 50¢ above a regular price regression should be or 50¢ below. That’s a $1.00 spread, and it gets down to bullish or bearish fund investors.
“Right now, funds are not bullish. But the inflation play could change that, I believe,” Suderman says.
As we head into the winter, money managers will be watching to see if the U.S. dollar stays strong and a favorable global currency, the economist says. If the Fed’s monetary policy begins to fail, it has to find another way to keep the economy stimulated.
Smart Money
Heading into September, the COT Report showed hedge funds’ net positions of corn, soybeans, Chicago wheat, and Kansas City wheat went positive for the first time in over two years.
Hedge funds are getting more active in the commodities sector. Their ownership, as a percent of open interest, went up to 40% between 2014 and 2017. Before that time period, hedge funds had 27% of ownership open interest. And now, that figure is climbing slightly. It’s the beginning of a turn higher, Suderman says.
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