The Market is not Efficient ... Sometimes

First, an update on the results of the corn trade from last month. Two weeks ago, I sold my corn future for 354.75 cents per bushel, netting a tidy sum of $800. Not bad, but what happened after that? It's climbed to almost 400 cents per bushel in fits and starts. Why? According to the news outlets, autumn rains across the Midwest have slowed down the harvest, raising worries that the predicted yields will be impacted. The harvest rate has been even slower than last year, and has fallen far short of the average rate of the last 5 years. The last 5 years saw some incredible droughts though, so there wasn't much to harvest to begin with especially in 2011 and 2012. I thought I would sell ahead of a week or so of good weather in Iowa, and then re-buy if the price dipped lower, but the price started going up on the USDA's crop progress reports. Essentially, the market didn't take the publicly available information I referenced last time until almost a month later, something you wouldn't expect the market would allow to happen if you believe in efficient markets.

In my courses at the University of Chicago, two of the basic assumptions that are taught are that arbitrage does not exist, and that the market is efficient in the sense that all "relevant" information is priced in at all times. I can understand that these assumptions are necessary for some of the models we study to hold up and/or to not be overly complicated, but time and time again they are clearly violated. In the corn example, all I looked at were USDA websites and some University of Nebraska sites on corn farming. Hell, the USDA reports even did the hard work for me of comparing this year's harvest rate to last year's and the average of the past five years. The farming sites told me that farmers will leave the crops to dry in the field instead of harvesting wet crops and spending money to dry them out mechanically.

Back in January, some of you might recall the polar vortex brought frigid weather across much of the US. One Thursday morning after the first polar vortex, I turned on the tv in the gym and heard the local WGN station reporting on a shortage of propane across several northern states. I thought, "Oh that's interesting, natural gas prices must be skyrocketing." On the contrary, natural gas was only up 1-2% on the day and had crawled up maybe 5% over the previous month. I tried to do some research during down time at work, looking for data on propane demand, any past shortages, natural gas availability, but didn't find any compelling evidence either way. At the end of the day, I figured that the market would have priced in wintry events like these and took into account the demand for heating fuels. Boy was I wrong. The next morning, I turned on the tv again, and that day all the national news outlets like CNN had picked up on the story. I flipped over to CNBC and sure enough, natural gas futures had opened up over 10%.

There have been other opportunities recently too taking advantage of lags in market response time. Hazmat suit makers' stocks didn't take off until after the man in Dallas died, despite the fact we've known about a case of infection in the US. The Hong Kong stock market didn't really plummet until mainstream news outlets gave it more attention even though democracy protests and violence had been going on for days.

My next idea revolves around natural gas. One of the reasons contributing to a propane shortage last year was that last year's huge corn harvest needed to be dried and stored. Under normal circumstances, corn can be dried efficiently by air. But the unprecedented harvest meant grain storers had to add some heat to speed up the process. If this year's harvest pans out, we might see a repeat of a shortage. In fact, I contemplated buying natural gas anyways as the price fell in October. It's not a terrible idea going into the winter as heating demand rises, and there's so much supply from the fracking revolution that some gas field operators flare the gas from their wells. That's when they would burn the gas right away rather than shipping it and storing it at some terminal overflowing with gas. Alas, natural gas prices jumped up 20% in a matter of weeks as I dawdled. (It has since come back down some.)

I'd love to hear everyone's thoughts and ideas.