Artificial market intelligence

Trading on the international futures markets has often been compared to the game of chess. There are so many inputs to consider in futures trading, and so many possible moves, it has even been likened to three-dimensional chess. As in chess, you are never actually trading the various inputs; you are actually trying to second-guess how other market participants–or your opponent–will react to those inputs.

As Keynes so aptly put it, “Successful investing is anticipating the anticipations of others.”

In his latest book, “21 Lessons for the 21st Century”, Yuval Noah Harari describes how artificial intelligence (AI) has transformed the world of chess. He writes,

“On 7 December 2017 a critical milestone was reached, not when a computer defeated a human at chess—that’s old news—but when Google’s AlphaZero program defeated the Stockfish 8 program. Stockfish 8 was the world’s computer chess champion for 2016. It had access to centuries of accumulated human experience in chess, as well as to decades of human experience. It was able to calculate 70 million chess positions per second. In contrast, AlphaZero performed only 80,000 such calculations per second, and its human creators never taught it any chess strategies—not even standard openings. Rather AlphaZero used the latest machine learning principles to self-learn chess by playing against itself. …

Can you guess how long it took AlphaZero to learn chess from scratch, prepare for the match against Stockfish, and develop its genius instincts? Four hours. That’s not a typo. For centuries chess was considered one of the crowning glories of human intelligence. AlphaZero went from utter ignorance to creative mastery in four hours, without the help of any human guide”.

Human chess players have sidestepped the problem (for them) of artificial intelligence by banning computers from human chess tournaments. Mr Harari writes,

“In human-only chess tournaments, judges are constantly on the lookout for players who try to cheat by secretly getting help from computers. One of the ways to catch cheats is to monitor the level of originality players display. If they play an exceptionally creative move, the judges will often suspect that this cannot possibly be a human move—it must be a computer move”.

As in chess, computers are now better than humans at trading futures. Fortunately—or unfortunately—futures markets cannot—or will not—ban computers from trading. This presents something of a problem for the physical trading houses, which have always relied on profits from trading futures to bolster/offset the tiny/negative margins that they make on trading physicals. As yet, the trade houses have failed to find a replacement for those missing profits.

But apart from the difficulties faced by the trading houses, what does it matter if computers now trade better than humans?

Futures markets have two roles to play: the first is to set a price (price discovery); the second is to provide a hedging medium. If computers are better at setting a price than humans, and if they provide lots of liquidity for physical hedging, then surely the world is better off.

As Mr Harari warns however, the difficulty arises when algorithms understand humans better than we understand ourselves. Once they do, computers can manipulate humans. This may already have happened in recent elections. If algorithms can nudge us into how to vote in elections, they can also nudge us into actions (such as selling at the bottom or buying at the top) in the futures markets.

Once futures market algorithms start to take money from physical hedgers, hedging becomes more expensive. When that happens, value is taken from producers and consumers of the physical commodity. Farmers are worse off, as too are consumers.

Some might argue that in any case trade houses always took value from the supply chain when they made profits from futures trading, already making farmers and consumers worse off. In that sense the owners of the algorithms have merely taken their place; the profits now go to the computers rather than the trade houses.

However, trade houses added value back into the process by efficiently moving physical commodities around the world. Apart from setting prices, it is hard to see what value algorithms return to the supply chain.

There is no obvious solution to this. Algorithms continue to get smarter while traditional physical trade houses continue to search for alternative business models. As Mr Harari writes,

“Already today, computers have made the financial system so complicated that few humans can understand it. As AI improves, we might soon reach a point where no human can make sense of it.”

Images under creative commons from pixabay.com

Trade Wars

In Imperial Twilight: The Opium War and the End of China’s Last Golden Age Stephen Platt, a professor of history at the University of Massachusetts, takes a long look at the events leading up to the Opium War that Britain fought with China from 1839 to 1842.

I found the book rather long, and it only seems to get moving in the last chapter when the war finally begins. However it is an easy read, and exceptionally well written and researched. It is therefore worth the effort, particularly as the book has relevance to current events, namely the trade war between the US and China, as well as the US’s current opiate epidemic.

In the late 18th century, Qing China was among the richest and most powerful empires in the world. However decline set in with a series of internal rebellions, increasing corruption, and (arguably) a rise in opium use by China’s ruling classes. The opium was grown in British India by, among others, the East India Company, and sold from British (and American) ships to Chinese traffickers who brought it into China, paid off customs officials, and distributed it domestically.

At that time China was the sole supplier of tea to the world, and demand was rising fast with Britain’s industrialisation. China was also a major exporter of silk, some of which travelled overland on the Silk Roads. The tea was mainly exported by sea, and trade was limited to Canton; Westerners were not allowed to trade from any of China’s other ports. This suited the East India Company, which had a monopoly on the trade to Britain, but was a bone of contention to the “free traders” such as Jardine and Matheson.

The British and Americans exported Indian opium to China in exchange for the silk and tea that China exported. Opium was illegal in China but the ban was only loosely enforced, at least until the late 1830s when the Chinese decided to enforce the ban, confiscating heroin from the Western traders and briefly holding them hostage in Canton.

Twenty years earlier, in July 1817, when Napoleon (Bonaparte) was living in exile on Saint Helena, his Irish physician Barry O’Meara (who had accompanied Napoleon in exile) told him that it didn’t matter if the British had the friendship of the Chinese because they had the Royal Navy. Platt quotes Napoleon’s response to his physician,

It would be the worst thing you have done for a number of years, to go to war with an immense empire like China…You would doubtless, at first succeed, but you would teach them their own strength. They would be compelled to adopt measures to defend themselves against you… they would build a fleet and in the course of time, defeat you.”

But twenty-two years later Britain did go to war with China. After intense lobbying from free traders, the British government agreed that the Chinese had to be punished for their treatment of the British traders and be taught to respect British superiority, to no longer have Canton as the only trade port, and to open further ports for trade. But behind it all perhaps the real motivation for the war was to force the Chinese to pay compensation for the opium that they had confiscated and destroyed, and to lift their domestic ban on opium, allowing the trade to once again flourish.

The young British politician William Gladstone—later to become four-time prime minister—said at the time, “a war more unjust in its origin, a war more calculated in its progress to cover this country in permanent disgrace, I do not know, and have not heard of.”

The war lasted for three years and ended with a British “victory” that was enshrined in the Treaty of Nanning, signed on 29th August 1842. Platt writes that it “was the first of what would come to be known as China’s “unequal treaties.” There would be many to join it over the course of the nineteenth century, for it marked a watershed in the Western discovery that one could get what one wanted from China through violence.”

He writes that the treaty “opened five of China’s port cities to British trade and residence, including Canton, Ningbo and, most importantly, Shanghai. The treaty gave Hong Kong to the British as a permanent colony.”

The Chinese regard the treaty as a major landmark in what they call their “century of humiliation” (1839-1945). However, Platt disagrees with their interpretation. He argues,

Only after the fall of the Qing dynasty in 1912 did historians in China begin to call this war “The Opium War” in Chinese, and only in the 1920s would republican propagandists finally transform it into its current incarnation as the bedrock of Chinese nationalism—the war in which the British forced opium down China’s throat, the shattering start to China’s century of victimhood, the fuel of vengeance for building a new Chinese future in the face of Western imperialism, Year Zero of the modern age.” 

He adds,

“The Opium War was not part of some long-term British imperial plan for China but rather a sudden departure from decades, if not centuries, of generally peaceful and respectful precedent. Neither did it result from some inevitable clash of civilizations.”

The debate will continue for some time as to whether the war was about British pride, or about finding an outlet for opium, one of British India’s most profitable export, or about forcing China to open up to foreign trade. Whichever of those three alternatives you chose, however, none are particularly glorious.

The first question that comes to mind is whether Britain, the world’s leading military power at the time, had the moral right to force their terms of trade on China? That question may have relevance today in the current trade war between China and the USA.

The second question is whether the US’s current opiate epidemic can be compared to the opium epidemic that contributed to China’s decline.

I am not qualified to answer either question and I will leave the final word to the review of the book from the New York Times:

Stephen Platt has written an enthralling account of the run-up to war between Britain and China during a century in which wealth and power were shifting inexorably from East to West. But if this history holds a lesson today — as wealth and power shift equally inexorably back from West to East — it is surely the same one that Karl Marx identified just a decade after the Opium War, that men make their own history, but they do not make it as they please.

Images from Pixabay under creative commons

The Pamir Highway

In Foreign Devils on the Silk Road, the author Peter Hopkirk traces the origin of the Silk Road back to Chang Ch’ien, a young Chinese traveler who was sent by Wu-ti, the Han Emperor to make contact with the Central Asian people, the Yueh-chih. The Emperor was looking for allies in his continuing conflicts with the Hsiung-nu, the ravaging Huns of our history books.

Chang Ch’ien set out in 138 BC but was captured by the Huns and held prisoner for ten years before escaping and continuing his journey. He eventually contacted the Yueh-chih only to find that they had no interested in joining forces against the Huns. Chang Ch’ien headed for home, only to be captured once again, and eventually made it back thirteen years after he had set out. Undeterred, the Emperor sent him out on another mission westwards and (as Peter Hopkirk writes),

Not long after his return from this mission, the Great Traveler died, greatly honoured by his emperor, and still revered in China today. It was he who blazed the trail westwards towards Europe, which was ultimately to link the two superpowers of the day—Imperial China and Imperial Rome. He could fairly be described as the father of the Silk Road.

The author continues,

Although one of the oldest of the world’s great highways, The Silk Road acquired this evocative name comparatively recently…As a description, it is somewhat misleading. For not only did this great caravan route across China, Central Asia and the Middle East consist of a number of roads, but it also carried a great deal more than just silk. Advancing year by year as the Han emperors pushed China’s frontiers further westwards, it was ever at the mercy of marauding Huns, Tibetans and others. In order to maintain the free flow of goods along the newly opened highway, the Chinese were obliged to police it with garrisons and watchtowers.

One branch of the Silk Road ran west from Kashgar, starting with a long and perilous ascent of the High Pamir, the “Roof of the World”. Here it passed out of Chinese territory into Central Asia…continuing through Persia and Iraq to the Mediterranean coast. From there ships carried the merchandise to Rome and Alexandria.

As Mark Twain is reputed to have said (but apparently didn’t), “History doesn’t repeat itself but it often rhymes”.

China (hopefully) does not want to conquer new territories, but it does want, and need, to conquer new markets for its goods. To do this it is investing heavily in new transport infrastructure eastwards through Central Asia and southwards through Pakistan to the Indian Ocean. Unlike (evidently) the US President, the Chinese realize that trade creates wealth.

Rather confusingly, the initiative is known in the western world as One Belt One Road, but the Chinese prefer to call it The Belt and Road Initiative (BRI) or the Silk Road Economic Belt, or even The 21st-Century Maritime Silk Road. The original Silk Road was not one road, but a network of land and sea routes. The new “Silk Road” is the same, although it includes both road and train routes.

The relatively short (albeit 1,500km) section of the Silk Road that I travelled last month is called the Pamir Highway, and runs from Osh in Kyrgyzstan to Dushanbe in Tajikistan. It first heads south along the Chinese border across the Pamir Mountains, and then turns west along the Wakhan Valley. The valley separates the Pamir Mountains and the Hindu Kush. It  is an isolated part of the world with an extraordinary mix of cultures: twenty-five ethnic groups and twenty-five languages.

The route follows the tumultuous and unnavigable Panje River, on one bank Tajikistan and on the other Afghanistan’s Wakhan Corridor, a narrow strip of land that was made part of Afghanistan in the nineteenth century to keep the Russian and British Empire apart. (For more on this fascinating period of history read Peter Hopkirk’s “The Great Game”.)

The Pamir Highway was in dire need of investment and improvement. Much of it was unpaved and single track, winding its way precariously along steep cliffs that dropped into the river below. I have no idea how the over-sized truck and trailer combinations that we saw on the road managed to make it from one end of the highway to another.

Some sections had been improved, and more works were being carried out, but the Tajik government is apparently wary of Chinese investment.

They probably shouldn’t be. Tajikistan is devoid of natural resources and is one of the poorest countries in Central Asia. Improving the transport infrastructure would not just permit Chinese goods to be imported more cheaply, it would help the country to develop as an important trading centre halfway between East and West.

The Heart of the Silk Road

The Jayma Bazaar, in Osh Kyrgyzstan, is one of the oldest in Central Asia and has existed on the same site for over two thousand years. The market stretches for more than one kilometre along the western bank of the Ak-Bura River, and has an estimated seven kilometres of alleyways and passages.

Osh is the second largest city in Kyrgyzstan and is situated near the country’s southern border with Uzbeckistan. The city is believed by some to be the location of the famous “Stone Tower”, which Claudius Ptolemy wrote about in his work Geography and which marked the midpoint on the ancient Silk Road between Europe and Asia.

Unsurprisingly for a city at the heart of the Silk Road Osh is known for its ethnic diversity. Traders from all China, Central Asia and Europe have been coming to Osh’s market for centuries and their social interaction has created a melting pot of different races and cultures. (Unfortunately this did not prevent strong anti-Uzbeck feeling from spilling over into a riot in June 2010 that left hundreds dead and destroyed parts of the market.)

The Jayma Bazaar is open seven days a week but I was lucky enough to visit it on Sunday, its busiest day. Many stalls are made from old container boxes and are grouped by product: one alleyway for shoes, another for hats. There is a meat and livestock section, as well as a square given over to craft blacksmiths making knives, horseshoes and cooking utensils.

The majority of the manufactured goods on sale were of Chinese origin, well-known brands that on closer inspection proved to be spelled wrong. Walking in the bazaar really drove home to me the extent to which China continually needs to expand the markets for its manufacturing sector. I began to understand better the important role that the country’s One Belt One Road initiative will play in China’s future development.

However a large section of the market was given over to seasonal fruits and vegetables with hundreds of stalls competing to sell apples, peaches, grapes and melons. There was also a huge quantity of dried fruits and nuts—raisins, apricots, dates, pistachios, walnuts, almonds and peanuts. China’s One Belt One Road project should also help Kyrgyzstan find export markets for its mainly agricultural economy.

That’s the good thing about trade and markets. They work both ways, and help all parties to better their lives.

Next week: Along the Silk Road from Osh to Dushanbe.

Agriculture and Chemicals: Part Two

Last week I wrote about three recent rulings that went “against” mainstream agribusiness. The first, by a Californian jury, found that glyphosate, a widely used herbicide, was carcinogenic and should be labeled as such. The second, by the EU Commission, was that partial bans on neonicotinoids, an important pesticide, should be extended and enlarged to prevent harm to bees. The third, by the EU Court of Justice, was that gene editing was a form of genetic modification and should come under existing GMO legislation.

The three rulings, coming as they did in close succession, made some wonder what the world has against agriculture in general and farmers in particular.

However, the rulings show the increasing disconnect between consumers and producers. The strong growth in demand for organic food highlights that consumers, particularly urban dwellers, increasingly want their food to be produced and delivered without herbicides or pesticides, and without its genes being modified or edited in any way. Farmers on the other hand want to produce as much food as they can from as little land as possible, and as cheaply as possible. Herbicides, pesticides and breeding techniques (whether genetic or “natural”) help farmers enormously in this task.

In a piece for Foreign Affairs Bill Gates put the case for research into gene editing, writing

This sort of research is vital, because a cow or a few chickens, goats, or sheep can make a big difference in the lives of the world’s poorest people, three-quarters of whom get their food and income by farming small plots of land…

Improving the productivity of crops is fundamental to ending extreme poverty. Sixty percent of people in sub-Saharan Africa earn their living by working the land. But given the region’s generally low agricultural productivity—yields of basic cereals are five times higher in North America—Africa remains a net importer of food. This gap between supply and demand will only grow as the number of mouths to feed increases. Africa’s population is expected to more than double by 2050, reaching 2.5 billion, and its food production will need to match that growth to feed everyone on the continent.

The challenge will become even more difficult as climate change threatens the livelihoods of smallholder farmers in Africa and South Asia. Improving the productivity of crops is fundamental to ending extreme poverty.

He continues,

Gene editing to make crops more abundant and resilient could be a lifesaver on a massive scale.

 In other words, we will have to improve agricultural yields if we want to feed the world and drag people out of poverty. Climate change will make food production even more difficult in the future, while at the same time we need to reduce agriculture’s carbon footprint, both in terms of its own emissions and in terms of forest erosion.

So we have a contradiction here: rich world consumers want their food produced organically, but at the same time they want farmers to use less land. This is a tough “ask” when the world’s population is increasing and when people are eating more meat. Adding a third objective of using agriculture to pull the world out of poverty makes the task even tougher.

However Bill Gates makes an important point when he mentions that cereal yields are five times higher in the US than they are in Africa. The EU beet producers were also right to point out that the extended ban on neonicotinoids would adversely affect beet yields. Against that, the recent increase in EU sugar production has helped to drive world sugar prices down to levels where many developing countries can no longer compete. (Huge production increases in India and Thailand were the main drivers, but the EU increase did contribute.)

You could therefore argue that advances in chemical and gene technology have already increased yields to such an extent that the world is producing too much food. You could add that the fact that these technological advances have largely benefited the developed world (and India and Thailand are part of the developed world), driving down production costs to a level at which under-developed countries, particularly in sub-Saharan Africa, cannot compete. This, as Bill Gates realizes, keeps them in poverty.

So maybe technology has got ahead of itself, (baring weather disasters) resulting in us producing too much food, too cheaply.

Some commentators have drawn parallels between the Californian ruling on glyphosate and the recent study that linked mobile phones and cancer. It is indeed curious that the press were quick to discount the mobile phone story on the basis that cancer rates haven’t increased with mobile phone use, but the media ignores the same logic when applied to glyphosate.

The media also ignore that logic when applied to sugar consumption and obesity. (Per capita sugar consumption has been falling for the past half century while obesity has been rising.)

Could it be that we apply different standards to products that we eat as opposed to products that we use? Could it be that we don’t care how the lithium is produced for our car batteries, but we do care how the wheat is produced for our bread?

Finally, there is the question as to whether the world is over-reacting in pushing back against farm chemicals. Some argue that every thing is to some degree carcinogenic (think sunshine and even toast), and that life is not risk-free.

However it may be appropriate to look back at the history of the insecticide Dichlorodiphenyltrichloroethane, commonly known as DDT. It was first synthesized in 1874 and was widely used in the second half of World War II to control malaria and typhus among civilians and troops.

DDT was made available for public sale in the United States in 1945 and was promoted by government and industry as an agricultural and household pesticide. Opposition to DDT was focused by the 1962 publication of Rachel Carson’s book Silent Spring, which claimed that DDT and other pesticides had been shown to cause cancer, and that their agricultural use was a threat to wildlife, particularly birds. The book’s publication resulted in a large public outcry that eventually led, in 1972, to a ban on DDT’s agricultural use in the United States.

Mosquitoes (not sharks or hippos) are the world’s most dangerous creatures. Over one million people die from malaria each year, mostly children under five years of age, with 90 per cent of malaria cases occurring in Sub-Saharan Africa. Some have argued that that fewer children would be dying if DDT hadn’t been banned.

However, DDT is still used in some parts of the world to combat malaria, and its use has been increasing since it was endorsed in 2006 by the World Health Organization. In many African countries, as well as India and North Korea, the pesticide is sprayed inside homes and buildings to kill mosquitoes. In 2007, at least 3,950 tons of DDT were sprayed for mosquito control in Africa and Asia, according to a report by the United Nations Environment Programme.

A panel of scientists from the United States and South Africa said DDT should only be used as a last resort in combating malaria. The 15 environmental health experts, who reviewed almost 500 health studies, concluded that DDT “should be used with caution, only when needed, and when no other effective, safe and affordable alternatives are locally available.”

The history of DDT may suggest that there is room for compromise on chemicals. Rather than outright bans, perhaps the solution would be to work where possible to reduce the use of chemicals in agriculture. But then compromises never make headlines or pay legal fees.

Images from Pixabay under Creative Commons

New award for Commodity Conversations

Commodity Conversations made it to the Best New Commodities eBooks

I’m happy to announce that my book, “Commodity Conversations: An Introduction to Trading in Agricultural Commodities”, made it to BookAuthority’s Best New Commodities eBooks:

BookAuthority collects and ranks the best books in the world, and it is a great honor to get this kind of recognition. Thank you for all your support!
The book is available for purchase on Amazon.

 

Agriculture and Chemicals: Part One

Last week, Monsanto—the agribusiness company that everyone loves to hate—was ordered to pay $US289 million to Mr. Dewayne Johnson, a former school groundskeeper, after a San Francisco jury ruled that the company’s popular Roundup weed killer contributed to the cancer that is killing him.

Glyphosate, the main ingredient in Roundup, was first approved for use in Monsanto’s weed killer in 1974, and has since been the subject of much emotive debate both in and out of the scientific community.

In September 2017, the  U.S. Environmental Protection Agency concluded a decades-long assessment of glyphosate risks and found that the chemical was not likely to be carcinogenic to humans. However, back in 2015, the International Agency for Research on Cancer, which is part of the World Health Organisation, classified it as a “probable human carcinogen”. Since then, California has added glyphosate to its list of chemicals known to cause cancer.

Mr Johnson’s lawsuit was the first to go to trial among hundreds filed in state and federal US courts that claim that Roundup causes non-Hodgkin’s lymphoma. Monsanto has said it will appeal the verdict.

However, the trial was an important test of the evidence against Monsanto, and will serve as a template for litigating thousands of other claims over the herbicide. Shares in Bayer AG (Monsanto’s parent company) fell sharply as investors weighed the potential costs of protracted legal battles. Bayer bought Monsanto for $66 billion in June this year.

Among the varied lawsuits against Monsanto is one from a bee keepers’ cooperative in France that claims that glyphosate is now widely found in honey. The US’s Food and Drug Administration also recently found traces of glyphosate in US honey, even apparently in “organic mountain honey”. The U.S. Organic Consumers Association and Beyond Pesticides filed a lawsuit against Sue Bee Honey of Sioux City, Iowa, because its honey tested positive for traces of glyphosate. The lawsuit said Sue Bee’s labelling, advertising its honey as “Pure” and “Natural,” is false and misleading. Another class action was started last year in Canada against a honey producer

Meanwhile, a federal judge in Brazil has ordered the suspension of products containing glyphosate until the government re-evaluates the chemical’s toxicology. France has already ruled that the herbicide will be phased out completely within five years.

Unsurprisingly, Monsanto has been accused of a corporate cover-up, with many on social media arguing that the company knew all along that their product causes cancer. Some scientists accused the company of “ghost writing” the scientific studies into the herbicide, and of trying “to destroy the United Nations’ cancer agency by any means possible” to save glyphosate.

Some on social media were quick to draw attention to an arguably similar ruling back in March where a Californian judge ruled that coffee companies will have to carry a cancer warning label because coffee contains acrylamide, a carcinogen. The acrylamide in coffee is formed early in the roasting process. All the foods we roast or fry also contain acrylamide, with 5 micrograms in a slice of toast or 7 micrograms in a bag of potato crisps, as examples. A cup of coffee has around 0.9 micrograms to 2.4 micrograms per 150 millilitre cup.

Others drew similarities between the Monsanto ruling and the recent EU’s almost complete ban on the use of neonicotinoid insecticides across the EU. Just as glyphosate is the world’s widest used herbicide, neonicotinoids are the most widely used insecticides. Back in 2013 the European Union opted for a partial ban on the use of the three chemicals in this class: Imidacloprid, clothianidin and thiamethoxam. The restrictions applied to crops including maize, wheat, barley, oats and oil seed rape. The newly agreed Commission regulation goes much further, meaning that almost all outdoor uses of the chemicals would be banned.

The action was driven by a recent report from the European Food Safety Authority (Efsa), which found that neonicotinoids posed a threat to many species of bees, no matter where or how they are used in the outdoor environment.

The decision is likely to particularly affect sugar beet production across the EU. The French sugar beet growers group CGB said, “This decision has a devastating impact on beet growing. With this ban, all French regions are likely to be affected by viral jaundice, with potential yield losses estimated at 12 pct at national level, and up to 50 pct in certain ocean climate zones.” Producers in the UK and Germany expressed similar opinions while others questioned whether neonicotinoids actually cause bee colony collapse disorder

These two latest rulings follow on from one by the European Court of Justice (on 25th July) that organisms obtained by mutagenesis plant breeding technique (gene-editing) are GMOs and should fall under the GMO Directive. The decision shocked the agriculture industry, which described it as a severe blow to innovation in EU agriculture and warned about economic and environmental consequences.

In a piece for Foreign Affairs published in April, Bill Gates outlined the case for using CRISPR and other gene-editing techniques on a global scale to meet growing demand for food and to improve disease prevention, particularly for malaria. “It would be a tragedy to pass up the opportunity,” he wrote.

In agriculture, Gates argues, gene-editing technologies could be used to make animals more productive while editing crops to withstand harsher growing conditions, or to include naturally occurring pesticides and herbicides, would improve crop yields.

These three rulings will make life more challenging for some farmers and may have major secondary implications. I will take up some of the issues in next week’s blog.

Images under Creative Commons from Pixabay

Fake news in the wheat market

Wheat prices spiked last week, reaching a three-year high, and then fell back down after Ukraine issued confusing statements on possible export limits. The trouble started when Ukraine said on Facebook that it planned to limit shipments of milling wheat. The ministry later tried to clarify things by saying that it was not discussing “strict limits” and would instead discuss projected shipment volumes with traders. The wheat price fell back pretty much to where it came from. The move can be seen on the following graph from Bloomberg.

The episode set off a social media storm. Some traders complained that journalists had acted irresponsibly by reporting on the original Facebook post without first checking on its accuracy. Others argued that the Facebook post was in itself a market-relevant event (even ignoring what it contained) and that needed to be circulated as quickly as possible. 

In an (excellent) article published after the event, Agricensus explained that,

The big two providers that control 56% of the market – Bloomberg and Reuters – have spent vast sums of money on improving latency by milliseconds – hoping that it gives their clients an edge in trading.

That puts pressure to print stories and market moving headlines, leaving reporters with little time to corroborate, double-check or even question the most ambiguous statements made by ministers and even world leaders.

Some commentators on social media complained that the episode was just another example of fake news. Others argued that you shouldn’t be trading on Facebook posts in the first place—and that if you want good information you should pay for it. However this ignores the fact that the original post was picked up by the big newswire services. And as Agricensus points out,

Global spending on financial market data analysis and news exceeded $28 billion in 2017, according to consultants Burton Taylor International – up 3.6% on the previous year and the highest growth rate since after the financial crisis.

 People are already paying huge sums for “real” news.

However, the idea that if you want real rather than fake news then you have to pay for it is one of the themes of Yuval Harari’s new book 21 Lessons for the 21st Century. The book will be released at the end of August, but in a prepublication interview Mr Harari tells The Guardian,

The idea of free information is extremely dangerous when it comes to the news industry. If there’s so much free information out there, how do you get people’s attention? This becomes the real commodity. At present there is an incentive in order to get your attention – and then sell it to advertisers and politicians and so forth – to create more and more sensational stories, irrespective of truth or relevance. Some of the fake news comes from manipulation by Russian hackers but much of it is simply because of the wrong incentive structure. There is no penalty for creating a sensational story that is not true. We’re willing to pay for high quality food and clothes and cars, so why not high quality information?

The Guardian has also published an extract from the book in which Mr Harari writes, 

In fact, humans have always lived in the age of post-truth. Homo sapiens is a post-truth species, whose power depends on creating and believing fictions. Ever since the stone age, self-reinforcing myths have served to unite human collectives. Indeed, Homo sapiens conquered this planet thanks above all to the unique human ability to create and spread fictions. We are the only mammals that can cooperate with numerous strangers because only we can invent fictional stories, spread them around, and convince millions of others to believe in them. As long as everybody believes in the same fictions, we all obey the same laws, and can thereby cooperate effectively.

He continues,

Joseph Goebbels, the Nazi propaganda maestro and perhaps the most accomplished media-wizard of the modern age, allegedly explained his method succinctly by stating that “A lie told once remains a lie, but a lie told a thousand times becomes the truth”. In Mein Kampf, Hitler wrote that “The most brilliant propagandist technique will yield no success unless one fundamental principle is borne in mind constantly – it must confine itself to a few points and repeat them over and over.” Can any present-day fake-news peddler improve on that?

Returning to the wheat market I understand that Ukraine always tracks and informally manages their wheat exports. Professional wheat traders were therefore surprised by the way that the market reacted to the Facebook post rather than by the Facebook post itself.

The post stampeded the herd—a herd that was already extremely nervous because of the extreme hot weather in many of the world’s wheat growing regions. Something else could have stampeded the herd: a rumour, say, or a big order hitting the screens—or even nothing at all. The herd was ready to stampede; it didn’t necessarily need an outside stimulus.

This type of situation is common in markets. Indeed, there was a lesser example just the week before when two famous wheat traders, Donald Trump and Jean-Claude Juncker announced that the EU would increase their purchases of US soybeans. The US soybean price rallied on the news and then fell again when the market realised that Trump and Juncker were not soybean traders after all.

There is an old commodity market saying that price will often go back to check out the extreme highs or lows made in a panic move, like the one in wheat last week. (This is not a prediction that the wheat price will return to last week’s highs, but I will be interested to see if it does.)

Finally, I had lunch with an old trader friend last week who reminded me that although traders love volatility, they don’t like political volatility; weather they can deal with, politics they can’t. Traders may or may not think that wheat prices will rise further on supply factors, but they have no way to foresee what the politicians will do in response.

As Bunge found out to their cost recently, it is dangerous to predict what politicians will do next, especially our present crop of politicians. As a result, traders normally increase the size of their bets in a fundamental market and reduce them in a political one.

Wheat has always been a “political” commodity; the current drought makes it even more so.

The Writing Was On The Wall

In his book Merchants of Grain (published in 1979), Dan Morgan describes the history of the grain trade and takes a look at what the future might hold for the five private companies—Cargill, Continental, Louis Dreyfus, Bunge and André—that at that time dominated the business.

The early 1970s had been exceptionally profitable for those five companies, and the seven families that controlled them. The Soviet Union was redirecting resources away from industrial production and towards consumers. Increasing meat supply was an integral part of that plan, but to do that the USSR had to import large amounts of protein and animal feed.

This coincided, in 1972, with the failure of the anchovy season off the west coast of South America (anchovies/fish meal was a significant source of animal feed at that time), as well as poor weather in the Black Earth region of the USSR.

The first wave of Soviet buying in 1972 came to be known as the “Great Grain Robbery”, and resulted in rising food prices and domestic inflation in the USA. It also began to focus political attention onto the grain trade, something that intensified when the Soviets came in for a second round of buying in 1975.

But that buying was a double-edged sword. As Dan Morgan writes, “Opportunities for big profits, which the companies had looked forward to in the doldrums of the 1950s and 1960s, certainly were present. But the enormous volumes and the volatility also created unprecedented risks.”

Continental Grain learnt this the hard way when they underestimated the depth of the second round of Soviet buying; the grain giant sold physical corn short, expecting to cover their sales when prices fell later in the year. But corn prices didn’t fall; they continued to climb and the company covered their shorts at the top of the market.

For Michel Fribourg, the owner of Continental Grain, this was a traumatic event, and he declined to offer any further tonnage when the Soviets came back for more in October 1975. A few months later he reorganized the company, firing traders and employing risk and business managers instead. As Dan Morgan writes, the risk in these big sales was just too big: “The glory days of the grand slams in the Russian trade were over.”

He continues,

“Continental was not the only company to experience trading troubles. Most of the companies now insisted that the Soviet Union share more of the risks. Louis Dreyfus, for its part, set up a system of compensating balance sheets with the Russians. In effect it worked for the Russians on a fixed commission; losses in any given transaction would have to be recovered in profits on subsequent transactions…”

At that time most commodity imports were handled by central government agencies within the importing country. Governments were generally assumed to be more reliable counter-parties than the private sector, but this belief was shaken when in early 1975 wheat prices fell and “Turkey’s wheat-importing agency cancelled the wheat import contracts it had concluded at higher prices with Continental, Bunge, and Cargill.”

At the same time, the state buying agencies in importing countries had begun to attract the US government’s attention in terms of the inducements and bribes that the grain companies paid to civil servants and politicians to get the business done. A new light was being shone on these practices. A new morality began to take hold within the US, leading to the Foreign Corrupt Practices Act that was passed in 1977.

A new light was also being shone on the shipping and transportation of the physical grain, leading to an FBI investigation in short-loading and falsified shipping documents at the Mississippi grain loading terminals. In 1975 a grand jury in New Orleans “issued a total of thirty-one indictments, covering 265 federal criminal violations against forty-eight individuals…All kinds of activities came to light that showed how company employees schemed to misgrade or diminish the quantities of grain destined for foreign countries.”

Meanwhile, anti-competitive practices were also being brought under the spotlight. “In December 1976, the Interstate Commerce Commission held hearings in Chicago to determine why some small grain elevators inland had been unable to obtain covered hopper cars and grain boxes to move their commodities…The hearings showed what a close relationship existed between certain railroad companies and the grain firms.”

Physical trading margins within the agricultural supply chain were almost as thin in the 1970s as they are now, and the big trading companies largely made their profits by speculating massively on the futures markets that they themselves dominated. But there again a new morality was beginning to take hold with the formation in April 1975 of the Commodities Futures Trading Commission, a new independent government agency to police the exchanges. It was formed “with fewer “policemen” than the Rockville, Maryland Police Department” and appeared to get off to a slow start, but it was a sign of things to come.

Perhaps more importantly, the big trading companies were already—in the 1970s—beginning to lose their domination of the agricultural futures markets.  Large well-financed speculators were moving in. The most famous were the Hunt brothers who had made a fortune early in the decade by squeezing the silver market. The brothers entered the soybean market in 1976, accumulating “approximately a third of the total beans that forecasters thought would be left over when the new soybeans from the 1977 crop became available. This was not a corner, but it was getting near to one”.

Their buying pushed prices higher and helped speed the demise of the publicly quoted Cook Industries, a former cotton trader that by the mid 1970s had begun to rival the traditional grain companies. “Within a year the company that Ned Cook had built into one of the highest-flying grain companies in the world had all but disappeared”. Cook was forced to sell its US grain elevators, allowing the Japanese trade houses Mitsui and Marubeni their long-awaited opportunity to get a foothold into the US grain business.

Taking all this together it is perhaps possible to pinpoint the start of the decline of the traditional grain business as a reaction to the massive price volatility and subsequent general inflation that followed the Russian purchases of US grain in the 1970s.

The grain companies had been hoping for such an event all through the doldrums of the 1950s and 1960s, but the consequences were greater government intervention and increased transparency, as well as the entry of well-financed speculators into markets that had previously been quietly local.

Bring those elements into a sector that was already struggling to cope with higher volumes and greater counter-party risks and you can begin to see that the writing was already on the wall. The era of seat-of-the pants buccaneering trading was on the way out; professional risk management, cost control and a new morality were on the way in.

Photos from Pixabay under Creative Commons