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Grain futures pools

09/10/2012 @ 10:56am

One of the new players in the grain-futures market caught a lot of attention this  summer, helping to fuel what was already a red-hot drought-driven market.

That new player is Teucrium, a family of investment products that has bundled pools of wheat, corn and soybean futures. These unleveraged, highly-transparent pools have made it easier for investors and speculators outside the agriculture industry to buy direct exposure to the grains.

The most popular, by far, is the corn-futures pool, which trades on the New York Stock Exchange electronic market under the trading symbol CORN. Assets in the pool, called an Exchange-Traded Product (ETP), shot from about $50 million in early June to about $110 million when corn prices peaked later in the summer. Even after corn backtracked a little in August, assets in CORN remained around $100 million.

In contrast, two other Teucrium pools of grain futures have attracted less interest so far. A wheat fund called WEAT stood around $3.1 million in late summer, and a soybean pool named SOYB held about $12 million.

Still, it was an active summer for Teucrium. "The drought effectively doubled our assets under management," said chief investment officer Sal Gilbertie.

He is hoping to attract even more assets due to the unique nature of his ETPs. Gilbertie, a former Cargill energy trader who's been active in the ethanol sector, calls his products "next-generation" ETPs, because they have been modified from some earlier approaches by other commodity-ETP suppliers.

Most notably, the earlier commodity ETPs focused on holding futures mostly from the front months. But Gilbertie argues that there are too many problems with front months, such as contango, backwardation, position limits and deliveries.

So Teucrium spreads its assets across two nearby months and a deferred "anchor" month. "For corn, the anchor month is always December. That's the month that reflects each year's harvest," says Gilbertie.

For WEAT (which holds only Chicago soft wheat futures) the anchor month is December. For SOYB, it's November.

Using CORN as an example, the fund will always hold its anchor month, December. When the nearby December contract is also the second or third month, CORN will hold two Decembers -- the nearby and the deferred. For example, if Dec 2012 is the second month listed on the futures board, CORN is required to hold 35 percent of assets in Dec 2012, 30 percent in March 2013 as the third listed month, and 35 percent in Dec 2013 as the "anchor" month.

Then, during futures-trading hours when old-crop contracts can diverge from new-crop contracts, Teucrium will constantly buy and sell futures to maintain the 35-30-35 mix.

This happens during traditional open-outcry futures-trading hours, which are about two hours shorter than CORN trading hours. CORN starts trading in New York about an hour before futures begin, and CORN continues trading about an hour longer than pit futures. That's important because if corn futures are not trading, investors and speculators anywhere in the world can still put in an order for CORN in New York. And they don't need a futures/margin account to do it, nor do they need a lot of money.

Similarly, it's important to remember that CORN may not exactly track the price of corn futures. While futures are open, CORN will reflect the price movements of its futures holdings, less fees and expenses. But when corn futures are closed, CORN simply reflects the prices that buyers and sellers are willing to pay in New York for CORN shares. (And Gilbertie encourages them to enter their desired share price, instead of being at the mercy of an unpriced “market” order.)

CORN buyers might be willing to pay more than the value of  its actual basket of corn futures, or they might insist on paying less. And CORN can trade with just a buyer or a seller, not both. Third parties, such as investment banks and professional traders, will take the other side of the transaction in order to keep the price of CORN close to the price of corn. Then, Teucrium will issue new shares to those third parties, or take back redeemed shares. And, importantly, Teucrium also places a futures trade in Chicago to offset the New York action.

The gap between CORN's price and the actual value of a 35-30-35 percent futures basket is kept to a minimum through a process called "arbitrage." Traders look at that gap to buy whichever is cheaper: corn or CORN. In that way, the gap can remain narrow. While corn pit futures are trading, the actual value of CORN's basket of futures changes rapidly. The NYSE computes it and publishes it every 15 seconds. Each quote provider uses a different symbol, but it can be found on Yahoo Finance under ^CORN-IV. It shows a price close to CORN, but it's a reference, not a tradeable vehicle. It represents what CORN would be worth if it were disassembled into individual futures contracts and sold back into the Chicago market. In contrast, the price of CORN represents what buyers and sellers are willing to pay for the assembled basket.

(At the end of the day, Teucriumcornfund.com publishes whether CORN finished at a premium or discount to ^CORN-IV. It's typically a small amount. Similar web pages are available for WEAT and SOYB.)
Significantly, CORN, WEAT and SOYB are shortable, so just as you can "go short" with Chicago futures, you can short these commodity ETPs. And there are put and call options available for CORN and SOYB, with the possibility of WEAT options in the future, says Gilbertie.

Farmers, especially those who already have futures accounts, may not find much use for CORN/WEAT/SOYB shares, but Gilbertie says a few farmers have bought in when they watched their crops wither in the field. With little grain to harvest, they replaced their expected crop with CORN shares, he says. That put them in a position to capture future price gains.

These commodity pools are not very old. CORN was launched in June 2010, and SOYB and WEAT in September 2011. An early buyer of CORN was Alan Weiss, a Connecticut money manager who runs accounts for wealthy investors around the country. In summer 2010, he put about 3% of their assets in CORN, buying in the mid-$20s.
With corn in an uptrend, CORN grew to about 6-7 percent of client assets. Using a proprietary climatological and supply-demand model that showed high risk and limited upside, Weiss sold half his positions, then liquidated all his clients' CORN later when the price reached the mid-$40s.

As a veteran stock investor, Weiss knows he can get exposure to agriculture through shares of companies like Deere and Monsanto. He can even buy pre-set pools like MOO, PAGG and VEGI that package Deere and Monsanto with fertilizer companies, and other ag stocks like ADM and DuPont (Pioneer seed).

But he prefers to own the actual agricultural commodities. "The trend is moving toward food shortages. There are certain long-term themes in this world − beyond the S&P 500 − that you need to pay attention to," says Weiss, who so far has used only CORN, not WEAT or SOYB.