Part One: The Markets that Spawned an Industry
It is always important to have a good understanding of any market’s unique specifications and its fundamentals before deciding to trade the specific market. However, what is also important, and often gets overlooked, is the specific market’s origin. One key benefit to this information is the added comfort that the trader will gain prior to participating in that market.
In this series, “Inside the Grain and Oilseed markets: a Six Part Series”, I will be discussing the ins and outs of these two major markets. To start us off, we will need to know how this particularly important sector of the commodity markets came to be. So, let’s take a brief look at how it all began.
The Beginning of Grain Futures
Before the system of grain trading we know today, grain was traded by farmers in a less efficient, more risk exposed manner. Prior to the establishment of the Chicago Board of Trade (CBOT), farmers were at the mercy of the market. When harvest time rolled around for farmers in the Midwest and they wanted to sell their grain (mainly wheat and corn), prices were typically low due to the ample supply in the market. Accordingly, when farmers needed to buy grain to plant during growing season, prices were high due to the scarcity of grain that time of year. Both situations caused chaos, sometimes even prompting farmers to burn their grain for fuel instead of selling it for a low price and paying transportation costs.
It was not until April 3, 1848 when 83 individuals, consisting of merchants, businessmen, urban pioneers, industrial visionaries, and other entrepreneurs, established the Chicago Board of Trade. The Board of Trade was established for the purpose of bringing to order the tumultuous Midwestern grain markets. The board allowed farmers to purchase what were known as “futures contracts”. This allowed the farmer to manage his risk against unpredictable price fluctuations in the market. Farmers were now able to protect themselves from paying too much and selling for too little.
At first, trading was slow due to the limited accessibility to certain markets via the CBOT. Tables turned when the Illinois and Michigan canals opened and allowed access from the Great Lakes to the Mississippi River, opening up new markets accessibility. In 1850, Chicago became the international headquarters for agricultural commodities. It was also self-regulated, meaning that all disputes and conflicts were handled in-house by “gentlemen’s rules”. By the end of the 1850s, the CBOT introduced a new grain grading system that allowed the markets to run more smoothly. The old system inspected a farmer’s grain many times during the selling process. This was to ensure that cleanliness and quality was where it was supposed to be. The new system allowed grain to be graded one time before storage, which was then placed in a bin with only grain of the same quality. Once sold, the farmer was issued a receipt for the amount of grain sold and its quality. This process also allowed for larger volumes of grain to be traded.
Arrival of the Speculator
With the increased volume brought about by the new grading system, the CBOT noticed one major issue that needed to be solved. At times, the market would find itself with more buyers than sellers, or with more demand in the market with no one to meet it. This allowed an opportunity for entrepreneurs to take their own money and act as both the buyer and seller with the hope of making money off the movement in price. The introduction of “market speculators”corrected this imbalance and provided critical market liquidity. These individuals would often get in and get out of trades hundreds of times a day just trying to profit from small moves in the market.
Introduction of New Contracts
After a near halt in trading at the CBOT during the World Wars, corn and wheat contracts had come under government control, denying speculative interest. The only markets that were allowed to be traded were rye and soybeans. Soybean futures trading arrived at the CBOT in 1936 and grew to be one of the CBOT’s most actively traded commodities. By 1950, soybean oil and soybean meal contracts were added. Later on down the road, the CBOT added its first non-grain commodity, iced broilers, which are no longer traded. Next in line were plywood and silver. By 1981, the CBOT had introduced all metals, currencies, bonds, energies, and even stock indices.
Where We Are Today
The grain and oilseed markets are more heavily traded today than ever before. New interest and more uses for wheat, corn, and soybeans have increased the popularity of these markets. Even though the majority of contacts are now traded electronically, the grain markets are still traded on the same fundamental purpose: to manage risk and to provide market liquidity.
There will always be a need for futures trading. Above all, grains pioneered an important marketplace for risk management that is necessary for everyday economic efficiency.
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