Grain markets bounce back after fears of AIG offload

17-Sep-2008 - Last updated on 18-Sep-2008 at 16:07 GMT

Corn, wheat and soy prices have made a quick recovery following emergency action by CME to prevent the market being flooded after the $85bn government bail-out of insurance giant AIG.

It was feared that American International Group (AIG) would quickly reduce its large positions in grains and livestock as it staved off bankruptcy, hitting commodity prices hard.

But CME Group, which claims to be the world's largest and most diverse derivatives exchange, announced on Tuesday that it was taking urgent measures to secure the markets by allowing AIG block trades, which are private transactions made outside of the public arena.

Christopher J Shanahan, research analyst, North America, chemicals, materials and food at Frost & Sullivan, told FoodNavigator-USA.com that although initially grain prices suffered they saw a rapid recovery once it was known that AIG's sell-off was supported outside of the market.

Shanahan added that it was likely the block trades would be at a discount and therefore would not have a major impact on the market. However, the buyers of AIG's open positions, one of which is rumored to be Cargill, may benefit if futures prices continue to go up.

The move by CME followed the $85bn rescue package offered to AIG by the Federal Reserve to avert further turmoil in global financial markets after the recent collapse of US investment bank Lehman Brothers.

The group, which is made up of Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT), said in a statement: “The agreed-upon order permits the limited execution of block trades by AIG in certain CME and CBOT commodity futures products, including Soybeans, Soybean Oil, Corn, Wheat, Live Cattle and Lean Hogs, for the purpose of liquidating a portion of AIG's open positions.”

If the emergency action had not been taken, falling commodity prices due to high volumes of selling would have initially been beneficial to manufacturers and ingredient companies, particularly in times of rising input costs, according to Shanahan.

But he added: “In the long run, these companies do not want to witness the collapse of major companies because of its potential impact on the economy and to future demand growth.

“This is a very significant action taken by CME and prudent.

“Rarely do these types of deals occur because it is a signal that a large investor (ie AIG) is not capable of fulfilling its obligations as dictated by its open contracts.

“If CME had not allowed for the block trade, then a large flood of discounted orders would have flooded the markets and would have taken the legs out from under the going commodity prices.

“Thus, CME had to ensure that the market could function properly post-AIG.”

AIG services

AIG is a world leader in insurance and financial services with operations in more than 130 countries. Its common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.

It also runs the Dow Jones-AIG Commodity Index (DJ-AIGCI), a broadly diversified index that allows investors to track commodity futures. The index is composed of futures contracts on physical commodities.

The DJ-AIGCI family includes eight sector sub-indexes that group the commodities by type and the DJ-AIG Grains Sub-Index includes corn, soybeans and wheat.

Joe Bedore, CBOT floor manager for trade house FC Stone, told Reuters that AIG’s commodities fund was likely to be about 75 percent the size of Goldman Sachs in CBOT corn futures.

He said: “Compared with Goldman who I think owns about 150,000 (contracts or 750 million bushels) of corn, AIG probably owns about 100,000 contracts (500 million bushels).”

“They (AIG) have a smaller position in soybeans, maybe 25,000-50,000, and in wheat around 20,000-25,000 and their soyoil holdings are about equal to wheat.”