Kub's Den

That's a Lot of Money

Elaine Kub
By  Elaine Kub , Contributing Analyst
Total open interest in cotton futures fell 14.5% since Jan. 26, at the same time the S&P 500 Index dropped 11.8%. (DTN chart by Elaine Kub)

Pretty much all of us -- anyone who owns some stocks, ETFs or mutual funds -- went through the same emotional rollercoaster during the past several weeks. Checking the balances of our investment accounts or IRAs became a pleasant daily ritual during the month of January: "Look how much more it's worth today than yesterday!"

Then it stopped being pleasant.

The volatile recent correction in the global equity markets has flushed trillions of dollars of wealth into oblivion. It was so violent, and involved so much money, that its spillover effects can be observed in the commodity markets, too, even though the fundamental worth of the energy contained in a bushel of corn hasn't shifted.

First of all, let's consider the stock market itself. It's debatable whether we should say that a rise in the S&P 500 Index, for instance, really represents wealth being "created." Perhaps we should consider real wealth being passed to investors only when it's paid out as dividends, or we should stipulate that gains and losses can only be realized once an asset is sold. But let's relax our interpretation a little bit and talk about the market capitalizations of the 500 companies included in that index, as they show up in the market value of millions of investors' brokerage accounts. Then we can say that between the last stock market correction (Jan. 20, 2016) and the recent all-time high (Jan. 26, 2018), the S&P 500's market capitalization grew by an estimated $9.5 trillion, of which $1.8 trillion was added on during the first month of 2018 alone. That represents a 58.5% gain over the past two years, followed by an 11.8% drop during nine trading sessions this February. That drop is equivalent to $3 trillion of wealth that has simply disappeared.

That's a lot of money!

Similar math can be done for the investment positions seen in various commodity futures markets, and it's eerie how closely investor behavior has echoed throughout multiple asset classes. Total open interest in crude oil futures on Jan. 26 was 55.8% higher than it was two years ago, then it fell 4.6% during the February stock market correction. In those same timeframes, total open interest in gold futures rose 35%, and then dropped 9.6%. Total open interest in cotton futures rose 68.0%, and then dropped 14.5%. Total open interest in corn futures rose 20.1%, and then dropped 1.3% during those panicky February days. Total open interest in soybean futures rose 18.1%, and then dropped 4.8%. Total open interest in wheat futures rose 40.1%, and then dropped 7.6%.

That's not to say there is or isn't a long-term correlation between the stock market's values and the total open interest in commodity futures -- there have been other, unrelated ups and downs in investors' participation in commodity futures over the past couple of years. But during this one, brief flash of fight-or-flight behavior, all these markets did seem to share some activity.

To put the commodity futures activity in dollar terms, in the soybean futures market, for instance, that 4.7% drop in open interest since the February stock market crash began could represent the equivalent of up to $49 million in margin deposits. Each time a speculator wants to buy or sell a soybean futures contract, it must deposit $1,300 of margin money in its brokerage account, which is not the full value of the soybeans being represented, but which serves as good-faith money to cover potential losses in the open position. When the speculator closes the futures position, it can get its margin money back and repurpose the cash for something else (covering stock market losses, for instance). This math isn't as direct as the wealth that's "created" or "lost" by stock market fluctuations, but it's still an observable flow of investment money.

However, just because investors' money was flowing out of the commodity futures markets this month, that doesn't automatically force prices to go down. Margin deposits are required for both long futures positions and short futures positions, so these formerly open positions that were closed in order to pull out margin money could have gone in either direction.

In fact, the most recent Commitments of Traders report from the CFTC showed that in the week leading up to Feb. 6, speculators (in the "managed money" category of trader) closed only 1,085 long soybean futures and options positions, but they jettisoned 12,956 short soybean futures and options positions. In the corn, SRW wheat, and HRW wheat futures and options markets, speculator activity has been similarly focused on covering short positions.

That is to say: Speculative investors were indeed pulling their cash out of futures and options, but they were doing so by buying back previously-established short positions. That buying activity -- for instance, the 11% (at least) decline in the number of short speculative corn futures and options positions -- may go a long way toward explaining the grain markets' remarkable recent success.

Grain owners have seen the actual value of their corn, soybeans and wheat rise more than 2.5% during the exact same timeframe that the sky has been falling around the ears of stock market investors.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

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Elaine Kub