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Published December 19, 2011, 05:46 PM

‘Unknown unknowns’ and grain prices

U.S. farmers can learn a thing or two about grain markets from Donald Rumsfeld’s line about “unknown unknowns,” says Neil Driscoll, grain platform trader with Louis Dreyfus Commodities.

There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.

— Former U.S. Secretary of Defense Donald Rumsfeld

U.S. farmers can learn a thing or two about grain markets from Donald Rumsfeld’s line about “unknown unknowns,” says Neil Driscoll, grain platform trader with Louis Dreyfus Commodities.

Index funds and speculators play a bigger role in grain prices than farmers might think,” he said.

Driscoll spoke Dec. 8 at the annual 2011 Prairie Grains Conference at the Alerus Center in Grand Forks, N.D. A record crowd of more than 700 people attended the event, sponsored by seven North Dakota and Minnesota farm organizations.

Typically, farmers focus on supply and demand when developing a marketing strategy. But other factors — which is where Rumsfeld’s “unknown unknowns” come in, can affect grain prices, too, Driscoll said.

“Is (supply and demand) really driving the day-to-day price action in our marketplace? Oftentimes, I think the answer is not,” he said.

Big investors and investment groups are contributing to daily price changes, he said.

“It only takes $15 billion to buy our entire wheat crop. It takes only $75 billion to buy our entire corn crop. It sounds like a lot of money to those of us in the room, but in the environment they work, people seem to be throwing around billions and trillions. It has a big impact on our markets, which in dollar terms really aren’t as big as you would think,” he said.

So, “Who are these guys? Who are these investors whose money is pouring into our marketplace?” he asked.

Index and ‘spec’ funds

Index funds are the easiest of the investors to identify. “This is the passive investor, this is the guy who’s worried about inflation and he wants to put a lot of money into a lot of different commodities,” Driscoll said.

Typically, such investors don’t pay much attention to price trends. They stay in the market regardless of whether prices rise or fall, he said.

Some people try to assess index funds’ impact on grain prices by determining when the funds buy or sell. “But that’s really not the right way to look at it. They’re a static guy who’s taken a bunch of liquidity out of the marketplace,” Driscoll said.

Liquidity is the extent to which an asset can be bought or sold without causing a big impact on its price.

By reducing liquidity, index funds “absolutely distorts our marketplace a lot,” Driscoll said.

The so-called spec (or speculative) funds also a big factor, he said. “These are the guys who I think create most of the day-to-day volatility.”

In some cases, he said, “We’re attracting people that trade our markets who don’t even care what wheat looks like.”

Farmers and others trying to develop a grain marketing strategy need to realize that the “unpredictability and volatility of the marketplace … is coming from things totally outside” supply and demand, he said. “It’s not an easy marketplace to navigate.”

Going forward, he said, “I think it’s important that every single day we tell ourselves, ‘The market is serving a lot of masters.’”

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