January 11, 2008 

Mr. David Stawick, Secretary 

Commodity Futures Trading Commission 

RECEIVED 

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Three Lafayette Center 

1155 21st Street NW. 

Washington, DC 20581 

Fax 202-418-5521 

Received CFTC 

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'it COMMENT. ~ . . ::· 

Email secretary@cftc.gov 

Re: Revision ofFederal Speculative Position Limits 

Our company - Advance Trading, Inc., Bloomington, Illinois - is involved in the trading 

of grain in the U.S. Over the last 2.5 years we have experienced an abrupt decrease in the 

"convergence" of cash grain prices with the futures-market prices in Chicago, Kansas 

City, and Minneapolis. In each of the seven agricultural and processed commodities 

traded on those exchanges, cash prices have increasingly failed to "converge," i.e., to 

reach an exact equivalence with futures, as is the primary function of futures markets, 

during each successive period when contracts expire. 

Agriculture is unique in that the entire year's supply is "manufactured" in one lump, at 

harvest time, creating a natural warehousing function in the industry: A huge quantity 

must be stored at harvest, to be allocated out as needed through the following summer. 

That is why there are forward futures contracts: To reflect a different future price relative 

to the spot contract, accurately representing carrying charges (i.e., warehousing profits) 

which signal the warehouseman (grain elevators) whether the market needs him to ship or 

store grain. Accurately reflecting cash-market carrying charges is the sole reason why 

futures markets were created, to avoid the boom-and-bust of each year's transition from 

an initial oversupply to final scarcity by transparently rationalizing the always-changing 

supply-and-demand reality of the moment. 

The mechanism, which keeps "paper" futures connected to cash prices, is convergence 

of the two, to the same price, during each successive futures contract's expiration. As a 

result, all participants are supposed to be able to view the nearby futures contract and 

know that its price will be precisely that of a well-defined grade of cash grain at the 

delivery point during that month. When that does not happen - or, worse, the current 

situation in which it structurally cannot happen- the futures markets revert back toward 

the boom-and-bust agricultural chaos that it was invented to solve. The less that futures 

serve as an accurate proxy for cash, the greater the risk for elevators and others involved 

in the grain business, having as one effect that elevators are forced to lower their bids to 

farmers to force wider margins for themselves - they have no choice. 

The current situation is severe enough, for structural reasons, that volatility is being 

forced into the cash markets, which the futures are unable to reflect. Specifically, basis 

levels are much lower than they would be if futures markets were functioning normally, 

which they cannot due to inflexibility in the current rules. 

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In a normal market, if basis levels were out-of-sync-low·to futures, a hedger could rely 

on relationships between futures widening to signal elevators to hold grain back -

providing an incentive to reduce their shipping volume - which makes cash-basis levels 

. climb back to the intended closer relationship with futures. That is how the futuresmarket mechanism keeps cash grain and "paper" futures properly related. Regardless of 

what grain prices are,.whether government biofuels subsidy sharply boosts price or huge 

hedge-fund speculation adds volatility, this cash-vs-futures connection must continue to 

function or the "real" grain business, and the futures prices themselves, are at risk of 

dysfunction. 

If additional futures-buying is introduced by increased speculative position limits while 

spreads are prevented from widening further to account for greater borrowing costs, etc. -

because they're already up against the artificial maximums in current rules - the 

divergence between cash and nearby futures ("cash basis') will be forced even lower. 

This doesn't just create loss and uncertainty for grain elevators, but also for farmers, 

industrial and livestock users, and everyone even peripherally involved. 

The National Grain and Feed Association's Country Elevator Committee made the 

following three comments: 

1. Increased volatility is being forced into the cash market, where country elevators 

continue to lose origination of farmer grain to long hedgers and organizations 

with large basis trading networks that can accomplish in cash that which cannot 

be accomplished in futures. In this environment, country elevators are unable to 

merchandise competitively without the confidence that convergence will occur. 

As such, the country elevator' s role as the first hedger of price risk in the market 

is in peril. Removing the country elevator from the merchandising chain 

potentially removes its vital function of price discovery from the marketplace. 

2. Increased volatility in the cash market has decreased the agricultural producer's 

ability to utilize futures for price discovery and risk transfer. 

3. Actions by traditional short hedgers to avoid the real or perceived risk due to the 

lack of consistent convergence are reducing utilization of futures. This is 

occurring at a time when the CFTC's proposals would increase the demand for 

liquidity to balance the demand by the index and hedge funds. 

The current market is unbalanced. A graphic expression of this is shown below. 
% Full Carry on 1st Notice Day 

This chart depicts the percentage of "full carry'' - the arbitrary maximum speCified in 

each futures contract's design - on "first notice day'' for the last ten years in each of the 

three major grain-futures contracts at the Chicago Board of Trade. In all of them, the 

futures "carry'' changed distinctly beginning in August 2005, to a far wider relationship, 

which has predominantly verged on the maximum allowed under the CBOT rules. Com 

averaged around 60% prior to Aug 2005, but 90% since. Soybeans averaged a negative 

36% before, positive 88% after. Wheat has other contract problems pertaining to grade, 

which had kept it at an extraordinarily wide 81% before, but it also widened further, to 

92%, after. 

What does it mean when the futures spreads in all three, through situations of relative 

oversupply and scarcity which are supposed to widen and narrow them to regulate those 

situations, are almost unchangingly at the limit allowed under.CBT rules? It says that that 

limit is restricting movement in the futures market so that it cannot reflect changes in, nor 

converge with, the cash grain market. So over the last 2.5 years, the basis has been forced 

to do the work that, due to contract design, the futures market cannot. Thus, especially 

with ever-larger speculative limits, the futures market price is, by definition, not very 

accurate relative to cash price a high percentage of the time. 

Without futures-exchange rules which allow sufficient flexibility for successful 

convergence under all price conditions, the resultant cash-futures divergence which the 

rules are aimed at preventing places the natural hedged short (the farmer and the country 
elevator) under so much pressure that he can be forced to withdraw from the futures 

market- a throwback to pre-futures-exchange days. That has already begun to happen. 

Essentially, while futures prices soar, the short futures hedger loses because his cash 

grain ownership becomes worth less relative to his hedge. Conversely, the long hedger 

profits by the artificial premium that the current rules confer on futures relative to the 

lower cash, when of course the two are supposed to be the same. 

The volatility of short hedgers' cash grain position is increased, while the volatility of 

long hedgers' position is reduced. Lack of convergence due to inflexible contract rules 

means that by design the longs are advantaged relative to the shorts. 

"Convergence" is the primary regulator of futures markets, which are of course free 

markets open to all. But how can CFTC enact position-limit expansion for speculators 

when that will exacerbate an already-severe, quantifiable problem with the grain futures 

contracts' basic functioning? Futures prices are already outrunning the delivery rules' 

ability to link them to actual cash grain prices. 

For these reasons, we think adding more speculative interest to a futures market that 

already is demonstrably unable to converge, therefore not functioning well, is imprudent. 

Until the exchanges adequately address the lack of convergence with changes in contract 

design, we oppose increasing speculative limits. 

Respectfully, 

Jeffrey W. Hainline