Odd Crop Prices: A Sign of Aliens in the Cornfield?

This one is by reader Kaleberg.

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Diana Henriques at the New York TImes has a fascinating article on Odd Crop Prices:

Economists note there should not be two prices for one thing at the same place and time. Could a drugstore sell two identical tubes of toothpaste, and charge 50 cents more for one of them? Of course not.

But, in effect, exactly that has been happening, repeatedly and mysteriously, in trading that sets prices for corn, soybeans and wheat — three of America’s biggest crops and, lately, popular targets for investors pouring into the volatile commodities market. Economists who have been studying this phenomenon say they are at a loss to explain it.

Whatever the reason, the price for a bushel of grain set in the derivatives markets has been substantially higher than the simultaneous price in the cash market.

When that happens, no one can be exactly sure which is the accurate price in these crucial commodity markets, an uncertainty that can influence food prices and production decisions around the world.

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A futures contract is an agreement to deliver a specific amount of a commodity — 5,000 bushels of wheat, say — on a certain date in the future. Such contracts are important hedging tools for farmers, grain elevators, commodity processors and anyone with a stake in future grain prices. A futures contract that calls for delivery of wheat in July may trade for more or less for each bushel than today’s cash market price. But as each day goes by, its price should move a bit closer to that day’s cash price. And on expiration day, when the bushels of wheat covered by that futures contract are due for delivery, their price should very nearly match the price in the cash market, allowing for a little market friction or major delivery disruptions like Hurricane Katrina.

But on dozens of occasions since early 2006, the futures contracts for corn, wheat and soybeans have expired at a price that was much higher than that day’s cash price for those grains.

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What is not happening in these markets is equally mysterious. Normally, price disparities like these are quickly exploited by arbitrage traders who buy goods in the cheap market and sell them in the expensive one. Their buying and selling quickly brings the prices back into balance — but that is not happening here.

“These are highly competitive markets with very experienced traders,” he said. “Yet they are leaving these profits alone? It just doesn’t make sense.”

Someone is leaving money on the table. Farm product futures prices are much higher than farm product prices even as time goes to zero. We have farmers up the gazoo around here, so I could actually buy and deliver a freight car full of broccoli seeds and make some money off a broccoli seed speculator.

My informed friend tells me that this is another sign of too much money, too few investment opportunities. The money has now sloshed into the commodities market and is distorting prices there. I am more inclined to believe that this has something to do with investment grade sardines and a decoupling of commodities and boxcars.

Does anyone else have any ideas?

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This one was by reader Kaleberg.