I was recently going through some old files and found this parody of a British Christmas carol. I wrote it back in the early 1990s when futures trading was still open outcry, rather than electronic as it is now.

I wish you all  a happy festive season and a wonderful 2019!

Good King Whileitlasts

Good King Whileitlasts look’d out, on a feast of tradin’,
All the trade lay round about, long and deeply laden.
Brightly climbed the price that night, through the spreads were cruel.
When a poor man came in sight, selling like a fool.

“Hither broker stand by me, if you know your calling.
Yonder local, who is he? From where comes all his selling?
“Sire he thinks it must make sense, perhaps against an option.
He has jumped down from the fence and now seeks out some action”.

“Take your cash and bring me mine, find another buyer,
Thou and I will make him whine, when we push it higher”.
Trade and broker forth they went, upward both together.
“The selling now must soon relate, it’s really now or never”.

“Sire, the market’s lower now and the shorts get stronger,
Fails my margins, I know not how; I can go no longer.”
“Mark my cards and turn my page, shout my orders boldly;
We shall make the sellers rage, if we take them coldly”.

Alas the longs were stopp’d out and their wealth lay dinted.
For the shorts there was no doubt, all their gold just glinted.
Therefore trading men be sure, wealth or rank possessing,
Ye who now will end up poor shall find yourself a blessing.

“We are becoming the value chain”

A conversation with Ian McIntosh, the CEO of Louis Dreyfus Company – Part Two

The CEOs of both LDC and Glencore Agriculture come from the sugar market, as did the previous Vice-Chairman of Cargill. Why do you think that ex-sugar traders reach such prominent positions in the business?

 That’s a question I didn’t expect! Sugar has always been a truly global commodity with a global futures market, a global geographic producer base – and a wide consumer base. It has a direct link to the end user through white sugar, as well as an intermediate refining stage. As such, it has the ability to teach you a lot about the different elements that you need to understand the business. People that come up through the grains or oilseeds tend to be from a smaller part of much bigger markets. Sugar propels you very rapidly into a global focus. Sugar has always been an excellent training ground for commodity traders.

Which leads me on to a difficult topic. The Brazilian sugarcane industry has been exceedingly challenging for companies such as yourselves and also Bunge. Can you see any end to the tunnel?

As you say that is a difficult question; it requires a lengthy answer, possibly too lengthy for this conversation. However, I will do my best to walk you through my thoughts.

First, you have to realise that sugar is a multi-faceted commodity. It is a food and energy commodity with a long cycle compared to grains and oil seeds. Sugar production responds relatively slowly to price. Sugarcane is a grass; once it is planted it stays in the ground and can be cut for up to six or seven years. As such the cycles are longer and more complicated.

Regarding the Brazilian sector, I read recently that Brazilian cane production had increased tenfold in the past ten years. That is complete nonsense. Cane production is up only a couple of percent on ten years ago, and there has been no expansion in area in the past five years. In addition, contrary to popular belief—and with one small exception—cane is not grown anywhere near the Amazon jungle.

Once the juice is squeezed out of the cane the dry matter, called bagasse, is burnt to provide electricity both for the mill and for the surrounding areas. The sludge, the vinasse, from the production process is reapplied to the land as fertilizer. The cane fields in Brazil are rain fed so there is no need for ground water irrigation, and wastewater from the mills is recycled and reused. All this means that sugarcane is a relatively environmentally-friendly crop.

In addition, about half of Brazil’s sugar cane is used for ethanol, nearly all of which is used domestically. The sugarcane absorbs carbon dioxide when it grows and some of this is then released back into the atmosphere as the ethanol is burned. In terms of net absorption and release, ethanol produces ten times fewer greenhouse gases than gasoline. This is extremely positive for the environment

Meanwhile, the majority of cars in Brazil are now what is called “flexfuel”: they can burn either gasoline or ethanol. In addition, the sugarcane mills have significant flexibility as to how much sugar they produce and how much ethanol. This provides tremendous flexibility to the mills and “optionality” to the trading companies that own them. Cane is therefore an attractive crop for companies such as ourselves who thrive on flexibility and optionality.

So the Brazilian sugarcane industry has all the ingredients for both economic and environmental success. However, the sector has suffered from government intervention. Successive governments have kept gasoline prices below their economic and environmental cost; this has made it difficult for ethanol to compete and resulted in losses for the sector. The president-elect seems supportive of the country’s domestic ethanol industry and we are optimistic that this situation will be changed going forward.

On the sugar side, world prices have been negatively affected over recent years by significant production increases in Thailand, India and Europe. It looks as if this is slowly changing: the current forecast is for a global sugar deficit for next year and the following year. So I think we will slowly be pulling out of this down cycle in sugar prices.

Having said that, there are still a lot of questions over long-term sugar consumption trends as well as over ethanol policy globally.

 Continental Grain sold their agricultural merchandising business many years ago to Cargill. They apparently felt at the time that the risks weren’t worth the rewards. How difficult is it for a company like LDC to shift these massive quantities of foodstuffs around the world while at the same time manage the associated risks?

That comes back to an earlier point. When Continental Grain sold their trading business most trading companies were trading in a traditional way. The current trend towards disintermediation makes it easier for us to manage our risk. It mitigates risk rather than increases it. If you are your own consumer you are taking your own credit risk.

It is also clear that diversification does have a clear benefit. A number of the companies that have either left the business or been consolidated were relatively narrow sector. The correlation across commodities varies: some are highly correlated but others aren’t. For example, the correlation between coffee and corn is low. The risk management benefits of a portfolio approach are significant, as too are the benefits of a diversified global footprint.

It is true that you have a different type of risk the further downstream you go, and the more you immerse yourself in developing economies. Back in the 1990s you were mainly concerned with market risk. Now you are concerned with market, geopolitical, country risk and company risk. Having an integrated approach mitigates that.

When I joined Cargill they always said that if you traded twenty commodities, five would have a lousy year, ten would have an OK year and five would have a stellar year.

 The last 20 years have proven that. You always have some sectors of the portfolio that are having a tough time while others are performing extremely well.

Trading conditions have been tough recently for the grain trading companies. To what extent do you think this is structural and to what extent cyclical?

Grain is a simple commodity with relatively low barriers to entry. It has an animal nutrition component and a human nutrition component. It also has a biofuel component through corn. Companies that are successful today in grains participate in all three sectors. The value proposition today is integrated logistics across geographies, and with links to oilseeds.

Having said that, a combination of over-supply and competition means that the grain market is currently difficult, but that is part of the cycle. All commodities are the same in that sense.

How do you see technological change affecting the business into the future, particularly Blockchain?

Blockchain is part of a broader move towards digital documentation. New technologies, like blockchain, can mitigate a number of risks and work well with traceability and the integrated value chain approach that we are pursuing. They represent a significant move in the right direction in making the agricultural supply chain appropriate to the requirements of consumers.

LDC did the first Blockchain transaction in agricultural commodities—a cargo of soybeans to China—and we intend to remain at the leading edge of technology. Having said that, I don’t see Blockchain as revenue transformative. I see it as a mandatory evolution of the value chain. Overcoming the challenges of integration, interoperability and industry standards will create a more robust, efficient and transparent way to manage our flows and reduce operational risk. It will also improve the credibility of the supply chain. In addition, it will lower barriers to entry and potentially bring more liquidity to our market.

About 30-40% of food is wasted between farm and fork. How can LDC help to reduce that wastage?

Most food waste occurs outside of the supply chain in which we operate. In most cases LDC is not a food producer, so our ability to reduce waste at the farmer level is limited. At the other end of the chain the fact that supermarkets sell goods with defined sell-by dates—that may or may not be appropriate—is not something that we can control. That is not to say that we have no desire to control it, but we have no interface with that. It is therefore wrong to say that the solution to food waste sits within the commodity-merchandising sector. There is virtually no waste in what we do, and quite often what we do regard as waste is a by-product, which is further used.

Would you recommend a young person to enter the business today?

Yes very strongly. We operate in a unique sector—and it is more unique now than ever—where you can combine an interest in geopolitics, with economics, with logistics, financial elements and at the same with industrial activities, and with agriculture. It is the most multi-faceted business that I can think of. That’s what attracted me to commodities in the first place.

One of the areas where a young trainee can come in and really make a difference is in how the world is nourished, and how farmers can not only survive, but thrive. In addition there is the whole area of traceability, sustainability, human rights…it is a hugely multi-faceted sector. For any young individual with an ambition to be part of a global business it is a great career.

LDC is an exception in that your chairperson is a woman, but the commodity merchandising business is generally male-dominated. Why do you think that is, and what should the industry be doing to encourage more women to join the sector?

That is an important question. It is important that we convey the message that this is an interesting career where people can make a real difference—where people can succeed. I strongly believe that there is no reason why that should be male or female—or anything—centric. Our business requires a broad set of skills that can be found in everyone, irrespective of their gender, nationality, etc.

As to why the percentage of females in senior management positions is low, it may be due to a combination of historical factors. Nothing would give me greater pleasure than to see a more balanced situation and I am committed to make that happen.

Commodity trading has always had the reputation of being very macho…

When I started in the business that was probably true, even to the noise level on the trading floor. We didn’t have instant messaging and electronic communications. You shouted down the telephone and if you weren’t getting your message across you shouted a bit louder. That did tend to come across as quite an aggressive environment, but that’s not to say that there weren’t some extremely successful female participants even then. My head of grains when I worked in Paris was female.

Commodity trading today is a much more diversified and complicated business We need the best talent that we can find, whatever the gender.

What advice would you give anyone joining the business today?

First, maintain a high level of ambition. Ours is an industry where people can progress very rapidly when they have the right skill sets. So don’t be afraid to push. People’s careers develop by filling vacuums. Vacuums occur all the time. You must never be afraid to put your hand up to fill the vacuum. People succeed in this business on their ability, not because of some hierarchy.

Second, remain humble. There is a graveyard of egos in this business. Recognize what you don’t know. Recognize that there are people that do know and learn from them. You can’t learn if you can’t listen. Listen to people.

Is there anything that you would like to add?

What I really want to stress is that preconceived notions of what a trade house is and does no longer apply. Those notions are outdated.

I would also like to emphasise the importance of adaptability. The companies that succeed are the ones that rapidly recognize change, and then adapt their structures and staff accordingly.

I started life as a “commodity trader” and I have never lost that trader’s DNA; it runs through everything I do. However, I and we as a company are much less traders than we were thirty years ago. And that trend will continue.

People still use the term “trade houses” to describe us, and I think it will be hard to change that. However, I don’t think there is such a thing as a trade house any more. We are all supply chain operators within the agricultural sector, but we are also nutrition companies. And we are all moving in our different directions.

But it will take a while for old mnemonics to change.

Ian, thank you very much for your time and for what has been an interesting conversation.

“We know where we are going”.

A conversation with Ian McIntosh, CEO of Louis Dreyfus Company – Part One

Good morning Ian, first of all congratulations on your recent appointment as CEO. Could you tell me a little about your career path with the company?

I joined Louis Dreyfus in 1986 as a trainee on their domestic grains desk in Norfolk in the UK. Relatively quickly I moved to London where I ended up running the UK grains desk before moving to Paris to trade global feed grains. After Paris I moved to Melbourne to trade Australasia grains. In 1993 I moved back to London as a sugar trader and in 1996 I took over as manager of the global sugar trading operation, which I ran until 2004, adding sequentially coffee, cocoa, rice, ethanol, grains.

In 2007/2008 I exited LDC to create a new company with the LD group, Edesia Asset Management. It had a brief to use the insights, information, access and skill sets gained at LDC to the benefit of third party capital, and to create a fund management entity. We launched in November 2008—which was probably the worst time ever to launch a hedge fund—but by 2010 we had $3 billion under management. We were one of the largest commodity focused asset management groups in the world. It was a great story.

By 2016 the hedge fund world was undergoing a period of change, a combination of investor dissatisfaction with commodity returns—not our returns, but commodities as a sector. This led to a large number of high profile hedge fund closures. We certainly saw a change in sentiment for hedge funds as a whole. In consequence we had gone from 52 investors in 2012 to 17 investors by end 2016 when our assets were running at $1.7 billion. We were still one of the largest, if not the largest, commodity hedge funds in the world, but we realised at the group level that the future of the business was uncertain. Concentrating on agriculture we had become a niche within a niche. We decided that we would profit from our successful track record and the ability to return capital to investors in a profitable performance year. We exited with a strong reputation and we moved key individuals, who had gained experience outside of the physical trading world, back into LDC.

We closed Edesia at the end of 2017 and I was asked to come back to LDC where I became Chief Strategy Officer. I took over as CEO in September 2018.

Knowing what you know now, do you think that there is a future for hedge funds in agricultural commodity markets?

Unless you have a deep understanding of the physical markets and the geographical relevancies of the different commodities it is challenging to be a hedge fund in the commodity sector. The necessary skill sets usually sit within large integrated physical commodity trading businesses. So in a sense the only way a hedge fund can succeed in commodities is by being closely aligned to a trade house’s geographic footprint and management.

That poses questions regarding structure and information conduits. We managed that challenge well at Edesia, but it is a big hurdle to any new start-ups. I suspect that the probability of success for any new entrant is low.

However, I do think there is a future for integrated asset management in commodities, but not necessarily via hedge funds. Our investor base in Edesia was primarily large pension funds, sovereign wealth funds, and corporate and state pension funds. Most of the commodity trading companies today are not listed, and it is difficult for investors to get access to what they are looking for—the relatively clear long-term agricultural story. There is an appetite for external capital to find a way into the sector. That may be through private equity or venture capital; it probably today isn’t through hedge funds.

Glencore recently opened up their agricultural commodity unit to outside capital. Is this something that LDC would consider?

That is a decision for our shareholders and Akira B.V. the Louis-Dreyfus family trust that has a majority shareholding in LDC. Our Chairperson, Margarita Louis-Dreyfus, has said on several occasions, including recently, that Akira wishes to keep all options open, with the interests of the company always as a priority. She has said that this could be in many forms, including strategic partnerships. So, no options are excluded. We are also looking to grow different parts of our business through joint ventures, partnerships, acquisitions, etc.

Algorithmic trading systems have changed the way markets move. Do you think that computers now make better traders than humans?

The advent of algorithmic trading systems is just one of the changes that the sector has experienced. Our business has changed completely since I joined back in the 1980s. I remember when I went on my first business trip to Russia; counterparts there didn’t even have fax machines, let alone Reuters screens or iPhones with instantaneous price discovery. Digital disruption, for want of a better expression, is a reality. Both consumers and producers are far better informed, and more rapidly informed, than ever before.

But the traditional trading companies still have an edge in their deep understanding of production and consumption economics, the value chain and the associated timing. Detailed supply and demand analysis still works. Price convergence in over- and under-supply markets still creates the traditional responses, whether it is on the flat price, in the time spreads or physical premiums. Market price moves to constrain supply and stimulate consumption in over-supplied markets, and vice versa. However, the path to that convergence has become ever more volatile.

Markets now arbitrage information instantaneously. Market price always reflects consensus. If there is a divergence between that consensus and what we consider to be reality then the question we have now to ask is, what route will the market take to achieve that convergence?

This is made harder by the fact that the discretionary capital in the futures markets has declined relative to non-discretionary capital. We now have a dominance of long only products, of high frequency traders, of macro-capital—which to be fair can be discretionary—that creates a distorting effect. If the fair value is x but the money flow pushes price to x+10 or x-10 it amplifies the convergence requirement. This forces—and I think the markets are still in an evolutionary process here—a rethink of traditional risk management techniques. The old school “we are right and we will wait to be proven right”—well, it just doesn’t work anymore.

What do you think is the biggest change in the business since you joined?

We have already talked about the digital revolution: how that applies to price; how it doesn’t change the opportunities but changes the methodologies that traders need to employ.

More important than that is the way in which the traditional role of the intermediary in the commodity markets has largely disappeared—or at least materially changed. A significant disintermediation has taken place. This has many different, but already widely discussed, drivers.

In the past, most trading houses have had an origination focus –and some of the new entrants into the business are still origination-centric. We at LDC see our role as value-chain managers; we are mandatory value-chain participants. To succeed today a trade house needs to be integrated along the value-chain, and to become less of a trader in the conventional sense.

And you think that LDC can still be relevant…can still add value to the supply chain?

Very much so. Take protein for example. It is a well-known story that the primary growth of protein consumption is in Asia; in particular, the rate of growth in China of meat demand exceeds China’s ability to produce the raw materials necessary to produce it. The rationale for this is well documented: a combination of GDP and population growth; urbanization; and a dietary shift towards more western diets. The reality is that as people get wealthier they eat more. This creates a systemic and material growth in protein consumption leading to a protein gap.

It is very easy in the west to have a preconceived view of China, but when you become immersed in the country you realize that China is jumping over many Western developmental steps. There is a clear desire to ensure that food can be traced—that consumers can be confident that it is safe. There have been a number of examples of food contamination as a result of the lead-time between the production and the consumption of the food. Many emerging countries are not used to the western supply chain model. If your food is coming through a semi-industrialised chain people need to be certain that what they are eating is safe.

When you visit some of the more innovative retail outlets in China it is astonishing to see the level of technology that they are using to ensure that the consumer has confidence in their food safety.

As a global commodity participant LDC can supply complete traceability where appropriate, or close to complete traceability where it is more difficult. In some cases we are ourselves the producers, and in other cases we are the direct link to the first producer. We not only handle the logistics but in some cases we are the industrial transformer.

It is different sector by sector within the agri-supply chain, but for a trading company to succeed it needs to have that integration. The margin is to be found in integrating the whole supply chain, not in any particular section of the supply chain. It is hard to make the statement today that the money is in originating beans or in trading beans. The margin is in the full value chain. It sits within the value chain. This move up and downstream is not something that is discretionary. It is mandatory. To fail to do that risks disappearance.

But when you have a traceable supply chain you lose flexibility and tradability.

Not necessarily. Once you have built the conduits for traceability that traceability is transferable.

But we not only have to make sure our commodities are traceable; we have to ensure that they are produced sustainably. This is something we take very seriously. The rate of adoption by the end user of the dual concepts of traceability and sustainability has been really rapid. It has become mainstream. To fail to do that results in marginalisation.

So once you put in place the conduits that ensure that your commodity is both traceable and sustainable the flexibility is still there. For example if you are selling Brazilian sugar into Indonesia and freight rates change you can flip that cargo to another destination while maintaining both sustainability and traceability. If a company is well structured you can then transfer that traceability – it isn’t lost.

It is this multi-geographic footprint that is important. One of the things that trading companies are realizing is that size really does matter. A trade house’s geographic footprint matters. I think trade houses with insufficient geographic footprint lose that flexibility.

Looking at your competitors, Glencore Agriculture says that 85 percent of their profits come from distribution and logistics and only 15 percent from trading. Cargill is making a big move into protein, and ADM into ingredients and higher value foodstuffs. Olam has done a successful move into what were once considered niche areas, but on such a large scale that they are no longer niche. Has LDC identified a particular focus area?

Yes, very much so. There are four pillars to our strategy.

The first is to build on and improve our traditional merchandising function. We recognize that traditional merchandising has changed, and we need to ensure that we have the correct geographical footprint and the correct information base to understand price evolution in order to maintain the flexibility that has always been a core element of profitability. That means maintaining the origination base. It also means increasing our consumptive footprint where appropriate. This can mean getting closer to the consumers in the case of coffee or sugar, or going further downstream in the case of oilseeds and grains. That plays into the logistics element.

The second is to recognize that disintermediation is real and that we either need to be closer to the consumer in an integrated value chain, or be a consumer ourselves. We see vertical integration and particularly vertical downstream integration as a core to our activities. An example of that is the new crushing plant that we have opened in Tianjin in China. This takes us down the animal protein route. It may mean going even further downstream, into bottled edible oils, or other branded products, or whatever is appropriate.

The third pillar, which follows on from that, is to move more into ingredients as an active participant in the food sector. We are already in that business, for example we produce glycerine and lecithin as an adjunct to the soya business, or citrus oils and essences from our orange juice business. These were traditionally considered as by-products. Clearly there is an opportunity here to identify cross commodity areas.

Our fourth pillar is innovation, not necessarily in technology, but in food. We are looking at the future of food, at alternative proteins and ingredients and working to be ahead of the curve in supplying consumer needs.

So we know where we are going. In five years time LDC will be more of a diversified food and nutrition company in addition to being a traditional commodity merchant. We have the strategy and the roadmap is clear. It is my task now to successfully implement that strategy.

What is LDC’s USP (Unique Selling Point)?

 LDC is differentiated by its long family heritage, the diversity and geographic spread of its agricultural product portfolio and the degree of integration across its value chain. Together, these factors give the company a unique identity and ability to leverage opportunities and mitigate risk over time.

 It is interesting to see the way that the different trade houses are evolving, the different paths they are taking. 

People tend to lump the ABCDs, as well as Glencore, COFCO, Olam and Wilmar into the same basket. But commodity companies now have different focuses; direct comparisons are no longer valid. The acronyms are no longer valid.

Part Two to be published next Monday

The full conversation will be published in the new Commodity Conversations book “Alphabet Soup” due out in autumn 2019.  

Farming comes full circle

I grew up on a farm; well more of a smallholding really, in the county of Kent, in southern England. My father had moved there after leaving the army at the end of the Second World War, and had borrowed some money to buy a small bakery and teashop in Canterbury. The teashop was one of the few buildings that were left standing in the city after Hitler had tried to destroy British morale by bombing Canterbury Cathedral, the home of Britain’s Anglican religion. His bombs missed the cathedral, but destroyed pretty much everything else in the city.

My father expanded the teashop, buying some old army buildings to open a restaurant and an outside catering business. However food was in short supply and his only solution was to grow his own. He borrowed money from the bank to buy some land on the outskirts of the city. He started farming it, and eventually built on it the family home where I grew up.

At the beginning, the farm was geared exclusively to produce fruit and vegetables for the restaurant. He planted fruit trees on some of the land; the rest of the farm was given over to potatoes and other root crops like turnips, parsnips and swedes, as well as cabbages, beans, brussel sprouts – all of which made up the standard British diet at that time. (It was only later that he branched out into strawberries, and even later into asparagus.)

In addition to growing fruit and vegetables, he also kept some chickens to produce the eggs for the restaurant, and pigs to eat the waste food from the bakery and the restaurant. The chickens and the pigs also produced the manure that served as natural fertiliser for growing the vegetables. It really was a circular, sustainable agricultural operation that grew what we would now call “organic” food—all with zero waste!

The farm also provided me with a very happy childhood where I learned how to drive a tractor at eight and how to plough a field at ten. I regularly helped out on the farm after school, and during the long school vacations.

As Britain slowly recovered from the war, food production picked up and prices fell. It began to make more sense for my father to buy the food he needed for his catering business, rather than to grow it himself. But he still wanted the pigs to consume the waste food from the restaurant and the unsold bread from the bakery. He abandoned vegetables (except for an acre or so to supply our family), and planted barley as feed for the pigs. He also bought more pigs, started a breeding programme, and within a few years had a small industrial farm, raising and breeding pigs.

Despite his hard work the operation was never a success.

One problem was what to do with all the effluent from the pigs. It was something that my father never found an effective solution to, but which—because of the smell—made us very unpopular with our neighbours in what had slowly become a residential area.

Another problem was the difficulty in keeping the pigs healthy; they were kept in such close confinement that they were constantly ill—and needed a constant supply of antibiotics to keep them free of disease. The veterinary bills soaked up the meagre profits that the operation was making.

The biggest problem, however, was one of scale. The farm was simply too small to compete with other bigger units both in the UK and continental Europe. At the time, UK pork prices were low with cheaper imports coming in from Holland’s bigger and more efficient pig farms.

My father tried to tackle the health problem by giving up barley production, and using the land to let the pigs roam freely in the open air. The pigs were healthier (and arguably happier), and the vet bills went down. On the negative side, the pigs gained weight more slowly. In addition, my father had to now buy in all the barley and the grain that he needed to feed the pigs. The economics of the operation just didn’t work.

My father died at the age of 102 and the family gave up farming, selling the land to the local hockey club. It was just part of the UK’s move from farming (and industry) to services.

However I am sure that if my father were alive today he would still be farming, and would have taken his small farm full circle, back to producing organic food with zero waste, and selling his produce at the local markets. Whether he would be able to make a living out of it, however, would be another question.

This is an extract from my upcoming book on the agricultural merchandising business.

Images from pixabay.com

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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