As computer models and algorithmic programmes exert a greater influence on commodities prices, traders are trying to get to grips with the digital forces that are changing how raw materials are bought and sold.
BayWa, the German agricultural trader, said this week it had partnered with Molinero Capital Management, a US fund specialising in computer-backed “quantitative” trading. Interest in systematic, algorithmic investing has exploded in recent years, and commodities have been no exception.
The German group said the aim of its tie-up — which follows its co-operation with German fund Quantumrock Capital, which focuses on high-frequency mathematical trading strategies — was to gain understanding of algorithmic and automated trading models and not looking to use them as sources of revenue.
BayWa wanted to “increase market insights in order to achieve a better predictability of price developments”. Louis Dreyfus, another agricultural commodity trader, has been developing its algorithmic research capabilities. Gonzalo Ramírez Martiarena, its chief executive, told the Financial Times Commodities Global Summit this year that he was working to further the group’s “algorithmic predictive analysis”.
Until recently, commodity markets have been driven by supply and demand factors of the physical raw material, with players commanding extra information on physical flows gaining an edge over other market participants.
However, the markets have become more accessible to a larger number of investors thanks to the increase in transparency and rise in information availability. Many commodity trading houses have looked to buy assets such as refineries, storage capacity and ports to increase access to information and gain control of distribution networks.
The digitisation of commodity trading is the latest development in the sector. Many “old style” traders relying on supply and demand fundamentals are struggling against computer models that process information in nanoseconds rather than milliseconds.
Speculative trading in agricultural commodities came under fire during the 2008-09 food price crisis that sparked riots in several countries, and the surge in grain prices after the 2012 US drought.
Despite the criticism, short-term trading in food commodities by speculators such as hedge funds has risen, accounting for almost half the volume in the futures contracts traded. According to a government study by two Commodity Futures Trading Commission research analysts, automated trading systems account for 48 per cent of all agricultural futures contracts on the CME compared with 38 per cent two years ago.
“We are seeing a strong impact these days from [managed money],” says Stefan Vogel, head of agricultural commodity research at Dutch lender Rabobank.
As a result, investors and traders are watching the positions taken by speculative investors disclosed by the CFTC closer than ever before as price swings in agricultural commodities over the past few years have been closely linked to their bets.
While the direction of the trades are defined broadly by supply and demand, computer models are also reacting to technical factors as well as macro reasons such as interest rates, foreign exchange and equity movements.
“Most of the daily volume you see trading is coming from algos,” said Santiago Torres Leon of Pathway Agriculture, an investment manager in Geneva. A small informational advantage over other sector players was not enough. “There is so much noise that a small edge in fundamentals is no edge at all,” he said.
Antti Belt and Eric Boudier of Boston Consulting Group say “the historical practice of trading by intuition, supported by limited analytics, is being replaced by more systematic, machine-based trading that utilises algorithms to support the collection and treatment of information and decision making process”.
In a recent report on digitisation of commodity trading, they advise that to compete in such an environment, market participants will need to invest in trading infrastructure and personnel who focus on software development and mathematics.
Additional reporting by Gregory Meyer in New York