The Market's Fine Print

Polishing Brass on the Titanic

Polishing brass and rearranging deck chairs on the Titanic doesn't help right the listing ship. (Engraving by Willy Stower)

Cluelessly tinkering with a serious problem can sometimes be worse than completely ignoring it. Instead of calming spectators and participants by at least doing something, empty gestures of help only work to intensify a real crisis of confidence.

That was my initial reaction late last week when the CME announced a sorry handful of actions designed to "enhance" live cattle futures. This token effort of reform included the following adjustments: 1) The imposition of a $1.50 per hundredweight discount on live cattle tendered to the Worthing, South Dakota, delivery location for the October contract only; 2) The updating of grading specs for the live cattle contract, adjusting par quality for both live and carcass-graded deliveries from 55% choice and 45% select to 60% and 40%, respectively; 3) A moratorium in listing any additional live cattle contract months beyond October 2017, pending further research and evaluation of ways to improve cash market transparency.

Now I'm sure each of these tweaks and stopgaps can make claim to their own inner logic. But their exacting focus strikes me as rather lame within the broader and fundamentally troubled context of a broken market. I mean fine-tuning is both worthwhile and necessary if you're starting with an expensive Swiss watch that somehow has drifted a few seconds off its game.

The alarming state of live cattle futures at this time (i.e., defying consistent and predictable basis behavior, the necessary core of risk management) is nothing like a still-valuable timepiece in need of just a little TLC. Indeed, the board's current status reminds me more of a worn-out working saddle, scraped with cracked cantle, split pommel and dangling horn.

In all fairness, it sounds like CME officials have some appreciation that a much bigger wound festers behind these three skimpy Band-Aids:

"We greatly value our relationship with the cattle community and are committed to helping producers and commercial firms manage their price risk," said Tim Andriesen, CME Group managing director of agricultural products. "Since the start of the year, we have been working with the NCBA and the broader industry to enhance our cattle futures markets. While we are announcing these changes and will continue our ongoing work with the industry, we have concerns about the lack of transparency of cash cattle markets."

In fact, the third change that postpones the listing of new contracts beyond October 2017 may represent the only honest recognition of the real market dilemma at hand. At least this implies that meaningful answers remain immediately elusive, even while the actual future of futures for commercial cattle producers (i.e., truly effective risk management) could be in jeopardy if none are eventually found.

The success of this desperate search may hinge on the ability of the CME Group and the beef industry in general to think outside the box. Currently, most are struggling to frame the question in traditional terms such as "cash discovery" and "transparency." While I recognize and even applaud the old market virtues such talk seeks to invoke, suggestions that reformers can somehow forge a significant consensus to roll back the clock on cash marketing are long on nostalgia and short on realism.

I hope the CME was at least partially agreeing with me in the way it rather cryptically ended last Friday's press release "We continue working with the industry to evaluate ways to improve cash market transparency, review cash market developments, and consider the introduction of cash-settled products if transparency does not improve."

What in the world could "cash-settled products" mean? Any new commodity that might fit under that heading would have to be firmly anchored in a negotiated cash trade (i.e., unlike live cattle). How about boxed beef? How about some kind of carcass equivalent? How about a weighted retail survey?

Yeah, I know. Those all have problems, including heavy doses of the same type of formula-pricing that has increasingly corrupted the cash feedlot market over the last few decades. Yet unless we can agree upon some set of contract specifications that openly trades along two paths (i.e., one commercial and one speculative), and ultimately converges in a predictable fashion, risk management will be nothing but an illusion.

Clearly, it's a tough fix. But polishing brass and rearranging deck chairs on the Titanic doesn't help right the listing ship. And just because the flames of Rome seemed to be raging out of control did not excuse Nero for reaching for his fiddle instead of a damn good fire extinguisher.

John Harrington can be reached

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