Steve:
I didn’t miss what you were saying about marketing choice. I just chose to help clarify a few things about markets in general. And we agree on most of it – farmers don’t need to trade futures directly; they can market grain quite effectively without a futures order; GPOs are just one way of doing this. From what you were writing, it appeared to me that you thought GPOs were somehow unique and not connected with the volatility of the futures markets. Perhaps I was wrong - clearly they are and I see now that we agree on that.
Also, you thought basis contracts gave the upper hand to the buyer (or the market) by having un-priced grain on the market and it appeared that you thought that this was not the case with GPOs. My point was that GPOs give the buyers much more market intelligence that basis contracts. So I’m suggesting - don’t be afraid of basis contracts for that reason, but be wary of GPOs for that reason.
Let me give an example. For many years, Japanese importers would buy canola on basis contracts, to be priced some time prior to shipment – much like basis contracts with farmers (but these are purchase contracts, not sales contracts). Some time, prior to shipment these Japanese importers would contact the exporter and give pricing orders to price the shipment. Basically, these orders would be the equivalent of saying something like, “buy 250 Jan canola at $390.00’ (this would price 5,000 tonnes of canola). The exporter would then be expected to buy futures at this price and provide a cash price based on this futures price. (The only reason the exporter would buy futures in this scenario is to remain hedged – if it didn’t want to be hedged and the futures went to $390, the exporter had the option to simply advise the Japanese importer that their contract is priced at $390 (and the exporter is now “short” at $390.) These orders (and GPOs) are not futures orders – they’re pricing orders. They are only filled when the futures price is met or exceeded, but futures don’t need to be bought or sold by the grain company in order to fill the pricing order.
But here’s what the Japanese figured out. When an exporter knows that they have a pricing order at $390, there is nothing stopping that company from stepping in front of that order and buying futures at $390.20 for itself. If it does, and the price never goes lower and actually moves higher, two things happen: (1) the Japanese pricing order is not filled and (2) the exporter has the opportunity to grab a tidy little speculating profit. If the price moves lower, the exporter prices the Japanese contract at $390, losing $0.20 a tonne on a spec position. The pricing order gives the exporter a backstop, limiting its risk substantially on a spec position .
The typical approach Japanese importers now take on unpriced contracts is to buy futures when they want through an independent broker and when time comes to price, they exchange futures with the exporter. (Using the example above, they would say to the exporter, “we will give up 250 Jan canola at $390 to price purchase contract X”. The exporter has no option but to take the futures and price the contract at $390.)
GPOs can benefit the grain company the same way. If they get a lot of GPOs at or near a particular price, they can front run these orders too, this time by selling in front of them. In this way, GPOs give grain companies a backstop limiting their risk on spec positions the same way as the Japanese pricing orders.
GPOs are a good way to park a pricing order and, yes, they do work. I’m just advising to be aware of the implications. A reasonable alternative is to pick a price (as you would with a GPO anyway) and when a grain company offers that price, take it. The downside of this is that you need to be more vigilant.
I didn’t miss what you were saying about marketing choice. I just chose to help clarify a few things about markets in general. And we agree on most of it – farmers don’t need to trade futures directly; they can market grain quite effectively without a futures order; GPOs are just one way of doing this. From what you were writing, it appeared to me that you thought GPOs were somehow unique and not connected with the volatility of the futures markets. Perhaps I was wrong - clearly they are and I see now that we agree on that.
Also, you thought basis contracts gave the upper hand to the buyer (or the market) by having un-priced grain on the market and it appeared that you thought that this was not the case with GPOs. My point was that GPOs give the buyers much more market intelligence that basis contracts. So I’m suggesting - don’t be afraid of basis contracts for that reason, but be wary of GPOs for that reason.
Let me give an example. For many years, Japanese importers would buy canola on basis contracts, to be priced some time prior to shipment – much like basis contracts with farmers (but these are purchase contracts, not sales contracts). Some time, prior to shipment these Japanese importers would contact the exporter and give pricing orders to price the shipment. Basically, these orders would be the equivalent of saying something like, “buy 250 Jan canola at $390.00’ (this would price 5,000 tonnes of canola). The exporter would then be expected to buy futures at this price and provide a cash price based on this futures price. (The only reason the exporter would buy futures in this scenario is to remain hedged – if it didn’t want to be hedged and the futures went to $390, the exporter had the option to simply advise the Japanese importer that their contract is priced at $390 (and the exporter is now “short” at $390.) These orders (and GPOs) are not futures orders – they’re pricing orders. They are only filled when the futures price is met or exceeded, but futures don’t need to be bought or sold by the grain company in order to fill the pricing order.
But here’s what the Japanese figured out. When an exporter knows that they have a pricing order at $390, there is nothing stopping that company from stepping in front of that order and buying futures at $390.20 for itself. If it does, and the price never goes lower and actually moves higher, two things happen: (1) the Japanese pricing order is not filled and (2) the exporter has the opportunity to grab a tidy little speculating profit. If the price moves lower, the exporter prices the Japanese contract at $390, losing $0.20 a tonne on a spec position. The pricing order gives the exporter a backstop, limiting its risk substantially on a spec position .
The typical approach Japanese importers now take on unpriced contracts is to buy futures when they want through an independent broker and when time comes to price, they exchange futures with the exporter. (Using the example above, they would say to the exporter, “we will give up 250 Jan canola at $390 to price purchase contract X”. The exporter has no option but to take the futures and price the contract at $390.)
GPOs can benefit the grain company the same way. If they get a lot of GPOs at or near a particular price, they can front run these orders too, this time by selling in front of them. In this way, GPOs give grain companies a backstop limiting their risk on spec positions the same way as the Japanese pricing orders.
GPOs are a good way to park a pricing order and, yes, they do work. I’m just advising to be aware of the implications. A reasonable alternative is to pick a price (as you would with a GPO anyway) and when a grain company offers that price, take it. The downside of this is that you need to be more vigilant.
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