CME Lean Hogs

CME lean hogs are on a tear to the upside. The April has rallied more than 500 points in less than 3 trading sessions.  Seems weird, they never go on a tear to the downside anymore.

The event that set the market off was hoof and mouth disease in South Korea. The market caught a bid and never looked back. However, the amount of meat that is affected is merely two days of kill. It’s not physically that much meat.

What really is to be pushing the market is the action on the screen. As I said previously, this market was driven to the screen by CME marketing execs.  They are unconcerned about market variables, they just worry about volume.

Volume for volume’s sake is not necessarily the sign of a healthy market.  Citibank shares are among the most traded.  It’s merely HFT firms chucking shares back and forth without any real attention being paid to long term investment or risk/reward.  There are other stocks like this too.  When things go awry, there is a flash crash.  Since the flash crash of May 6 there have been several flash crashes in individual stocks.

Funds control what happens on the screen.  There are so many “buy only” funds, it can distort the price for a short time.  Eventually, the market has to merge to the cash price.  But it can be very expensive while waiting to get there.   In the old days of pit traded hogs, big locals and hedgers were able to spread and bring discipline to an overheated market.  They were able to take on the buy only funds.  Today, that discipline is gone, and the market runs unbridled.

Very experienced hog traders have said that virtually all their supply and demand knowledge, all the supply and demand cues they get from the cash market make no sense when applied to the current futures market.  Spread relationships that have held true for years are out of whack.  Seasonal trends in hogs don’t make any sense at all.  I don’t think this is a function of a world market, because we have always had export business when it came to hogs.

It’s not just the movement to the screen, but it’s the way the screens interact with smaller marketplaces.  Lean Hogs is a very small, specialized market.  It’s on the verge of being broken and so disjointed that players will simply walk away.  Similar things have happened in the coffee, cocoa and other small specialized markets.

Advocates and apologists for the screen say there is nothing to see here.   They say critics are whistling past the graveyard.  However, many of the critics I know are not criticizing the screen per se.  They are criticizing the way technology interacts with the marketplace causing massive distortion.  Academic theorists are correct that if the market is out of line, simply take a short or long position and arbitrage it.  That is not so simple to do in futures, and there is not enough risk capital laying around in the world laying around to arbitrage every market that gets out of line.

I am not against technology. However, it needs to be used properly to ensure efficient and orderly markets. Applying one generic solution to all markets makes about as much sense as applying the ideas of one size fits all that big government advocates encourage.

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