How the grains market works

A market organised around one year 

A grain market differs from a metal or an energy market in one structural respect that governs everything else: supply arrives once. A field is planted, it grows, it is harvested, and the quantity produced is then fixed until the following year. There is no equivalent of increasing production in response to a price, because the plants are already in the ground and the weather has already happened. Everything the market does between one harvest and the next is an attempt to work out how much was actually produced and how it will be shared between competing uses until more arrives.

The market therefore distinguishes old crop from new crop, and treats them almost as separate goods. Old crop is grain already harvested and in storage, whose quantity is known and dwindling. New crop is grain not yet harvested, whose quantity is an estimate that changes with every weather forecast. Delivery months either side of a harvest reference these two different things, which is why the price step across a harvest boundary can be large without implying anything about direction.

The hemispheres partially offset each other. A northern hemisphere harvest arrives in the second half of the calendar year and a southern hemisphere harvest in the first, so a market that would otherwise be blind between harvests receives an intervening crop. Wheat is the clearest case, being grown across so many latitudes that some part of the world is harvesting at almost any time, which is one reason it is the most widely traded of the cereals.

The four crops and their uses 

• Corn. Overwhelmingly a feed grain and an industrial feedstock rather than a food eaten directly, with livestock feeding and ethanol production the two largest uses in North America. Its demand is therefore tied to livestock economics and to fuel policy as much as to food.
• Wheat. A food grain, milled into flour, and the crop with the greatest political salience because bread prices are a domestic political matter in many importing countries. Quality classes differ substantially and are not interchangeable, so several distinct wheat contracts exist for different milling qualities and origins.
• Soybeans. Grown to be crushed rather than consumed whole, yielding a protein meal used in animal feed and an oil used in food and biodiesel. The bean, the meal and the oil each trade, and the relationship between them is a processing margin in the same sense a refinery's crack spread is.
• Oats. A smaller market by a wide margin, with a narrow production base and correspondingly thin depth, which makes its price movements larger and its quoted spreads wider than the other three.

The crops compete for the same acres, and that competition is the market's principal supply mechanism. A farmer choosing between corn and soybeans on the same field compares the expected revenue of each against its cost, so the ratio between the two prices in the months before planting influences how much of each gets planted, and therefore the supply of both in the following year.

The calendar, and the reports that punctuate it 

The agricultural year runs through planting, an early growth phase, a short critical window in which the yield is effectively determined, and then harvest. The critical window is the part traders concentrate on: pollination in corn and pod setting in soybeans occupy only a few weeks, and heat or drought during those weeks reduces yield in a way that later favourable weather cannot repair. Weather forecasts covering that window move prices more than forecasts covering any other part of the season.

Official statistics give the market its fixed points. The United States agriculture department publishes a planting intentions survey before the season, weekly crop condition and progress ratings through it, quarterly stocks reports, and a monthly world supply and demand estimate that consolidates production, consumption, trade and ending stocks for every major crop and country. Those releases are scheduled, their timing is published in advance, and the convention is to read each figure against the range of trade estimates rather than against the previous month.

Export demand is the other recurring input, and it is where geopolitics enters. A small number of countries account for most of the world's exportable surplus and a different small number for most of the import demand, so trade policy, export restrictions, currency moves in exporting countries and conflict affecting a major growing region or its shipping routes all reach the price directly. The Black Sea region's share of world wheat and corn exports is large enough that its access to shipping is itself a price input.

Stocks to use, the measure of tightness 

The standard measure of how tight a grain market is compares the quantity expected to be left at the end of the marketing year with the quantity consumed during it. Expressed as a ratio, it states how much of a year's consumption is held in reserve, and it is the number analysts reach for because it is comparable across crops and across years in a way that a raw tonnage is not. A low ratio describes a market with little margin for a production shortfall, and it is the condition under which a weather scare produces a large move.

The last row shows why grain markets react to modest looking production revisions. Because ending stocks are a residual, meaning what is left after use is subtracted from supply, a revision that is small relative to total production is large relative to the residual. A cut of a few percent in a crop can take a double digit percentage off the stocks that remain, and the ratio moves accordingly.

Who trades them 

• Farmers, who forward sell a portion of a crop that is still in the ground in order to fix a price against costs already incurred, and grain elevators who buy from them and carry the physical position.
• Processors: millers, crushers, feed compounders and ethanol plants, hedging the margin between the grain they buy and the product they sell.
• Exporters and importing state buyers, including national purchasing agencies that tender for large volumes on a published schedule.
• Livestock producers, for whom feed is the dominant cost and a grain hedge is a hedge on their own margin.
• Funds and speculators, whose positioning is reported weekly in the regulator's classification of open positions.

When they trade 

Grains keep an unusual split session inherited from the exchange floor era. An overnight electronic session covers the Asian and European hours, then the market pauses, and a day session covers the North American morning and early afternoon, which is when the official reports are released and when the great majority of volume trades. The exact hours and the pause are published per instrument in its contract specifications.

The pause matters because major reports are timed to land within the day session rather than while the market is closed, and because the reopening after the pause is a routine gapping point. Exchanges also apply daily price limits to grain contracts, meaning trading is restricted once a price has moved a stated distance from the previous settlement, and a market that reaches its limit can stop trading with orders unfilled. That is a structural feature of these contracts rather than an exceptional event.

How a CFD on a grain settles 

A contract for difference on a grain references the price of the underlying futures contract and settles in cash. No grain is delivered, no elevator receipt is issued and no grading obligation arises. The conventional unit is the bushel, a volume measure that corresponds to a different weight for each crop, and prices are quoted in US cents per bushel. The difference between the opening and the closing price is multiplied by the number of bushels the contract covers.

Profit and loss is calculated on the full notional value while only a percentage of it is posted as margin, so an adverse move is measured against the whole contract and a loss can exhaust the margin posted rather than being limited to it, with a favourable move measured identically. The daily price limits described above are relevant to that arithmetic, because a market that has stopped at its limit can reopen at a different price on the following session.

Grain contracts are listed on harvest linked delivery months rather than on every calendar month, so an instrument referencing one inherits that month's last trading day and is closed at the prevailing price or rolled into the next listed month on a date published in the specifications. Where the roll crosses a harvest boundary it moves from an old crop contract to a new crop one, and the price difference between them reflects two different crops rather than the cost of carry alone.