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Traderade at the EU

Hello Traderade family,

Yesterday I had the privilege of representing Traderade at a working group at the European Union - specifically, European Economic and Social Committee.

The working group was to discuss "Food price crisis: the role of speculation and concrete proposals for action in the aftermath of the Ukraine war".

My role was to give them a practical view on how we trade in the agricultural markets and more specifically, the role of retail traders and how we require more information and knowledge to empower retail traders, just as we do here at Traderade.

I thought you may like to read the 10-minute presentation I gave and the slides that went along with it.

Good morning! I am Ayesha Tariq, co-founder of Traderade, a firm dedicated to teaching retail traders about financial markets. Thank you for inviting me today. Today I’ll be speaking about the role of speculation in the soft commodities markets from a trader’s perspective.

I will walk you through a practical overview of what we saw while trading these markets as recent geopolitical events unfolded. We will look at how traders are still dealing with volatility, what we’re seeing terms of price action and finally what we think of the agriculture markets from a financial perspective.

The Macro Landscape and What’s Driving Price Discovery

We all know the events that unfolded earlier this year when geopolitical turmoil hit Europe back in February.

But the stage had been set for higher prices during 2020 and 2021 because of the excess liquidity that had entered the financial markets, as we can see from this chart. Commodities began to outperform equities over this same period of time.

Prices in agricultural commodities also started to increase significantly after the pandemic.

Prior to that, over the past several years, there has been a reduction in investments in the agricultural space and despite efforts from governments around the world, food security still remains a concern. Weather conditions have become more extreme and crop production has become less predictable.

How traders are dealing with the current state of volatility and general market positioning

The events that occurred in Europe added more stress to the market at a time when prices where already soaring. The markets went into a state of disarray and retail traders were still trying to make sense of the situation. Commodity trading firms and large traders & hedgers set the tone for the markets and retail traders followed suit.

Price discovery certainly becomes more challenging in times of stress. What we saw was bid-ask spreads widening considerably as liquidity in the market became scarce. This can be seen in the yellow highlighted portions on these charts.

In times of extreme stress, market makers and other high frequency traders often reduce their position and order book participation as their risk of loss increases from greater volatility. This is exactly what happened and, it became much more challenging to execute at a good price.

Bid ask spreads represent the cost to buy or sell a contract, and when they widen it exaggerates price movements because participants must pay a greater price to buy or sell for a lower price to exit.

This widening of spreads led to higher implied and realized volatility. Hedging through options became more expensive as dealers repriced risk. Nevertheless, market participants did step in to take positions.

A point to remember is that many retail traders tend to be price action or momentum traders which mean they follow the market trend often based on news and sentiment, in an attempt to make a profit.

And price now remains in backwardation for most of the agricultural markets, although some markets more than others as we can see in these charts. This means that near-term or front-month contracts are more expensive that contracts further out.

Many traders are still taking advantage of the price curve being in backwardation by shorting near dated futures to buy back at lower prices in the future.

This however, contradicts with a great many retail traders who take long positions either buying futures through mini contracts or buying ETFs or the options on the ETFs.

This is yet another situation that is making price discovery much more challenging.

At present, because the markets are bullish near-term, we're seeing a significant level of open interest in the front month contracts, particularly on the buy side. As we see in these chart, the open interest and trading volumes are higher than future dated contacts. This is clearly a sign of speculation regarding the tightness of supply as most hedgers would be participating more in future-dated contracts.

Following the aftermath of the events, volatility still remains at very elevated levels compared to prior years.

The Catalysts and Risks affecting Prices in the Short and Medium-Term

What we're seeing in the commodity space is a mix of positve and negative catalysts on commodity prices that continue to keep the market volatile.

While the market still remains in backwardation with front month prices higher than further out, we have seen prices soften in the last couple of months.

  • One major concern is the risk of further geopolitical escalation that could cause prices to increase.

  • However, the strength of the US Dollar and the rate hikes across the world has created a situation where we are likely to experience a global recession. An impending recession will push more managed money and speculative traders out of the market, causing prices and demand for commodity instruments to decrease.

  • We are also seeing liquidity being drained from the financial markets in general by large scale quantitative tightening, which will also cause prices to decrease.

In the medium-term, we are seeing the market tell us that the short-term risks could lead to a lower commodity prices in general, as demand is eroded and we enter a global recession, that may continue for 2 years.

Nevertheless, there are a few catalysts that could cause prices to escalate:

  • Again, the geopolitical situation not only in Europe but also in Asia

  • We've seen the price of oil increasing that could put further pressure on fertilizer and energy prices and therefore, farm input costs

  • planting acreage in the US, a major supplier of the ag complex is also almost at maximum capacity and European harvest remains constrained

  • weather disruptions across the globe are disrupting patterns of supply

Structural Changes facing the Agricultural Market in the Long Term

Finally, I'd like to look at some of the structural changes that we are seeing in the agricultural market in general and the financial markets for agriculture.

  • We continue to see longer term price pressures in the space. And this is mainly because we believe that the agriculture industry is plagued with underinvestment. We still need to make major strides in terms of technology to find better ways of sustainable farming. Arable land is dwindling and the environmental concerns are getting worse. We certainly need more businesses looking at this.

  • One of the ways to attract investments is to ensure that the financial markets remain liquid.

  • Over the last decade we have seen an influx of investors and traders who take positions in commodity instruments - whether through equities involved in the ag space such as Deere or Archer Daniels Midland or through direct investments in futures contracts and ETFs. This has given a rise to a significant increase in liquidity in the market.

  • Now while most of these traders or investors are looking at these instruments as pure speculative products, it still fosters a market where we can have more efficiency in terms of tighter bid-ask spreads and better execution.

  • Even large scale commodity firms who trade in the physical commodity benefit from a more liquid market for hedging their costs. Furthermore, even producers (or commercial hedgers) are able to hedge at lower prices, thus ensuring that their overall cost of production remains low.

We realize that all this gives rise to speculation and therefore, a fair degree of volatility in the markets. However, this is why we need a better flow of information and knowledge, to the point where there is limited level of asymmetrical information in the markets.

Retail traders have become a formidable force and they can often move the financial markets in unexpected ways. Quite often, trades are made based on pure speculation of events and even on unsubstantiated rumours. This is why it is imperative that information flows more freely across all participants such that, no one is at a particular disadvantage. This will reduce the level of “uninformed” speculation.

This is also where companies like Traderade come in. We're trying to educate traders and investors on cyclical and structural market changes for investing and at the same ensure that there is more informed participation.

Our view is that the free flow of information is definitely required to foster more efficient markets, better price discovery, less volatility and smoother trading.

Thank you all for your time today

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