A Walkthrough on the Origin and Evolution of the Commodity Futures...

A Walkthrough on the Origin and Evolution of the Commodity Futures Market

Stephane Bernhard, Managing Director, GROUPE INVIVO

Stephane Bernhard, Managing Director, GROUPE INVIVO

In the light of your experience, what are the trends you’ve witnessed happening with respect to the commodity trading?

The commodity trading space has been lagging the tech push, especially grained to the Ag commodities and equities, bonds, forex, or even energy market. The space has been in this state for a long time even though with the existence of Chicago Mercantile Exchange (a global trading group which has been around for a long time).

When I started 25 years ago, it was a space where it was all about insight information, customer relationship, and knowing what the European, Chinese, Russians, and Washington politicians would do because of grains and the highly strategic commodity. And it was all about networking and having special information, and the analytics was a cold edge asset.

It was the market driven by states and governments through aid programs and subsidies. In 1994 it was a non-tech space. At the end of the 90s, the world turned towards more global markets even though some of the Western countries still supported agriculture. So it was a more free market, and that’s when Ag commodities were seen as other commodities by companies such as Goldman Sachs as an asset and funds started to enter the space.

"Human being with the right technology to empower himself would be more creative than a pure machine"

Today the market has turned digital with more participants, quant funds, pop traders, and systematic strategies. Then if we look at the edge of the commodity, the level of insights that commodity traders had, nobody else had in terms of information of crops, and demand. And having these insights was the key edge to profitable trading. This was one aspect. The second part was up to 10 years ago; the financing function was a key edge as well. It was tough for farmers, producers, or end users to get easy access to finance and hence the commodity traders had two sources of revenues or two edges— one, information, that nobody else had and a significant advantage in financing. If you owned the stores, it gave you an immense advantage, and you could generate good revenue and build better strategies for deliveries.

But currently, any farmer, producer in the world or user of grain, seed millers, starch producing, and ethanol producers have almost the same information about the global and local supply-demand than any commodity trader. It’s important to ensure everybody has that information as it is a big game changer. But since everybody has those insights and it’s easy to get financing, commodity traders have lost their natural edge. So it’s no longer a key for those markets. But that explains a lot of what has happened in the future market and the OTC’s (over-the-counter). Today, farmers have all the information they need to hedge their crop and also industrial users have access to financing, hedging tools through digital platforms, auctions, and OTC’s to hedge their risks. This is a major challenge that traders have today—to find their edge.

We do not have a natural edge anymore. Grain merchants and commodity traders had a natural edge coming to their function in the physical market but today is not the case anymore. The business is asset-intensive and the future market or the types of strategies that are driving the markets will have a big impact. Grain and commodity markets are small markets compared to forex, equities, or low-interest rates markets. So even if big institutional investors, like pension funds, insurance companies and sovereign funds allocate a small part of their assets to the Ag space, they play a crucial role in those markets. So I would say this is the big cultural evolution over the last 25 years.

Most of the traders are trying to adapt and invest more in technology and analytics and getting more intel-based approach to risk management analysis. They are seeing an acceleration of algorithmic strategies, systematic fundamental on the analytic side and much more because now they have access to a lot of historical data. For instance, there are weather stations everywhere which would be a predictor of crop sizes. So it’s accelerating in terms of big data and analytics but at the same time exposure to technology such as AI is a challenge for the companies to adapt to.

According to you what is the major pain point affecting the Trading arena?

Historically it was all about how to fund the business and to build the network of contacts to get an advantage in terms of information. Today all of that doesn’t generate value anymore. So the challenge is to create the structure to capitalize on the amount of data that the business generates. To generate profitable trading strategies, generate optimizations in terms of logistics.

Going from a world where the commodity was non-tech to dealing with a big amount of data and generating a niche out of a process is a substantial change in culture. For these types of commodity traders, we are right now in the shift of conviction trading. So the bottom line is the ability to dig in all the available data to generate an edge compared to the competition.

How would you see the evolution a few years from now with regard to disruptions and transformations within the arena?

One of the issues that we’re facing in the Ag market is that it is difficult for any trader to generate sustainable alpha. The reason for that is that everybody has access to computing power, data, the techniques that are used, and mathematical or logical concepts. So it has become a race for finding the new edge. But along with the access to all of these, having an original strategy will help to be sustainable and robust.

So, the big challenge going forward for the hedge fund industry or commodity traders is what type of edge you have in an environment where the central banks are intervening in the economy, and interest rates are low. Thus, creating alpha is a primary challenge. To create alpha for anybody basing it on technology is not sufficient in the cycle of advantage.

According to me, there should be a blend of human expertise and machine. I believe much more in an Iron Man than a Terminator. As I strongly opine that “human being with the right technology to empower himself would be more creative than a pure machine,” and that’s the challenge. So I am looking forward to knowing what can AI and algorithms bring to enhance powers to human creativity.

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