Pork Bellies are Bacon

The Wall Street Journal has an article on Pork Bellies today. I know a little about Pork Bellies. I have traded Lean Hogs for the latter half of my career.  The Pork Belly contract made the $CME.  The CBOT was always the big boy in town.  The CME was a puny Butter and Egg exchange.  CME tried other contracts, onions for example.  There was so much abuse in the trade that they banned trading in onions in 1958.  The Belly contract was started in 1961.

Some background, pork bellies are the raw meat from a hog that is turned into bacon. Currently, the belly is receiving some fame on plates in higher end restaurants. Asians have loved pork belly for centuries. It has made the jump across the Pacific to the US. Pork Belly prepared correctly is a delectable mouth watering treat.

If you want to follow the daily price of bellies, look here.  These are the voluntarily reported prices to the USDA.  Soon, we will have mandatory price reporting which should provide better cash price information to the market.  Yesterday, the price of bellies was .9423, unchanged from the day before.

Among traders of a certain era, the belly contract is legendary.  Many fortunes were made in that pit.  The price of bellies is extremely volatile.  In its day, the belly pit was like the S+P futures pit.  Huge intraday moves up and down which offered plenty of opportunities to scalp the market.  The success of the belly contract attracted traders.  This pumped up seat prices at the CME.  Success lead to the innovative culture at CME.  The belly contract lead to development of Live Hogs, Live Cattle, and eventually to the financial futures contracts that the CME used to become an international marketplace. CME would not be where it is today without the bellies.

When I started at the CME, I was a runner for Stotler and Company next to the belly pit.  The pit was a virtual zoo, and it was full of characters.  There was more drama in that pit than a soap opera on TV. The question is why did it all end?

There are several reasons for the contracts demise.

The pit itself shares some of the blame. Some brokers and locals saw the amount of profit that could be made out of trading against order flow and continuously ripped off customers.  It’s not unlike a lot of the HFT and algo programming that takes place today.  Sniffing, quote stuffing, orders that seek other big orders, flash quoting.  HFT firms running the stops.  Wall Street has seen trading volumes drop because of the nefarious activity that remains unchecked and codified by the SEC, CFTC and exchanges today.  The retail customer lost confidence in the bellies, and they have lost confidence in the stock market.  The deck was and is stacked against them.  Retail people never get a fair shake anymore, and are the personal pigeons of the market place.

The CME also bears some of the blame.  Markets evolve.  The CME stuck with a belly contract that was invented for 1961.  It is a frozen contract.  The industry moved to fresh bellies, and hence the frozen contract lost a lot of its meaning.  Instead of listing another contract, or changing the existing one, CME sat on its hands.  After being so innovative, CME lost its ability to think out of the box.  The bellies also never made the jump to the computer screen when the contract was healthier.  To take a dead contract and put it on a screen is not doing anything at all.

Then there is the industry itself.  In 1961, there were lots of meatpackers, lots of farmers, and lots of producers.  The industry was fragmented up and down the supply chain.  Today, the industry is more vertically integrated.  The market doesn’t have to use a publicly listed contract to manage its risk.  It uses privately negotiated OTC contracts instead.  Counter party risk is less of a concern, so the CME clearing house is not needed.  The industry changed dramatically, and the contract didn’t adapt.

As the pit started its demise, trading talent left for greener pastures. Some belly traders went and tried their hand at financial futures. Others went to more actively traded agricultural markets. This loss of human capital was bad for the market. There are still plenty of old belly traders that walk the floors of CME. They don’t like to see the end of belly futures anymore than anyone else.

Commodity funds that became a big presence in the commodity futures markets at the turn of the century (2000) never traded the bellies. It was not because it was a deliverable commodity. Funds trade oil, cattle, grains, softs which are all deliverable. It was because there wasn’t any volume in the first place. Funds have to be able to get out of positions. They were guaranteed losers if they traded bellies.

However, the industry is still better off with a good, tradable public market.  These two lines from the article leave a clue,

“For independent bacon processors, the decline of the pork-belly futures contract has meant that belly prices are becoming a mystery. The amount they pay for spot bellies is now based on a daily price quoted by the Agriculture Department, which collects it from producers on a voluntary basis.

This year, spot prices have soared 45% from June to an all-time high of $1.60 a pound in September, before tumbling back to a low of 88 cents by late October. Now they fetch around 96 cents. “It’s getting completely out of whack,” said Chris Kunzler, president of Kunzler & Co., a Lancaster, Pa., bacon processor.

Bellies are going the way of onions.  Onion prices are more volatile than oil prices. It’s time to rethink the belly contract. It’s also time to start trading futures contracts in more things, not less. Price discovery and consumers will benefit.  But the unwillingness of the SEC, CFTC and exchanges to correctly regulate and manage the electronic marketplace makes starting new contracts almost impossible.

Read more at Points and Figures