Commodities: a gamble that ysyakkt doesn't pay off

March 31, 1994|By David Conn | David Conn,Sun Staff Writer

Not since Dan Aykroyd and Eddie Murphy made a killing in frozen orange juice futures in the 1983 film "Trading Places" have commodities been so much on the public mind.

This time the event that put this growing but still relatively arcane investment field on the map was the news that Hillary Rodham Clinton in 1978 managed to parlay a $1,000 bet on cattle futures into a $98,000 windfall.

It's the kind of performance that raises dollar signs in the eyes of even the most conservative investors. But professionals, both regulators and industry members, warn that commodities trading, although an ancient tool of commerce, is not for the faint-hearted.

"There was one fellow in Connecticut, who made $200 million trading coffee, who lives out of the back of his car now," said Jeff Blanchford, a commodity trader in the PaineWebber Inc. office in Melville, N.Y.

Mr. Blanchford and others in the industry pointed out that Mrs. Clinton's success was extraordinary, given the small amount of money she started with and her relative lack of expertise in commodity trading.

For instance, even famous Wall Street investor George Soros recently disclosed that he lost $600 million on Valentine's Day betting the wrong way on the Japanese yen.

Mrs. Clinton apparently benefited at least partly from the advice of sophisticated investors, including an executive with Tyson Foods Inc. and her broker at the Springdale, Ark., securities firm of Refco Inc. She also rode the biggest bull market -- no pun intended -- in cattle futures this century.

But the industry consensus is that at least three out of four individual commodities investors lose money over time, and possibly as many as nine out of 10. While it's true that the amount of money lost will roughly equal the amount won, the number of people who consistently lose far outnumbers the number of consistent winners.

That's due to a number of factors, including the level of volatility inherent in some types of commodities trading and the lack of sophistication of many of those investors.

Ironically, commodities trading arose out of a need to limit risk, not increase it. The Chicago Board of Trade was established in 1848 as a way for farmers during the spring to protect the investment in their crops against possible price declines by the time the harvest rolled around.

Today agricultural products underlie only a small percentage of all futures trades, which is the most common type of commodity investment. There are exchanges that sell futures contracts for everything from cattle and pork bellies to lumber, cotton, silk, petroleum products, foreign currencies, stocks and government bonds.

Plenty of investors still want to hedge the prices of the products they make or sell, but the majority of traders are speculators, those who have no interest in the commodities themselves but hope to gain according to the constant price changes in those goods.

The basic futures contract gives the investor the right to buy a certain amount of a commodity, for a predetermined price at a specified future date, typically no more than a few months later. If the price of the commodity rises, the futures contract also rises in value, and vice versa if the commodity price declines.

Investors almost always sell off their contracts before the expiration date, and never come home to find 40 tons of pork bellies dumped on their lawns.

But what can make futures investing so risky is that brokerage firms allow customers to invest by putting up only a very small percentage of the value of the contract. For example, the cost today of buying one $30,000 contract for June cattle futures is $540, or 1.8 percent, according to Mr. Blanchford of PaineWebber. By contrast, most stock brokerages will require a "margin" of no less than 50 percent of the stocks' value.

Mrs. Clinton made a $1,000 bet on her first trade that paid off more than five-fold. From there, she continued trading larger and larger amounts, with mostly successful bets, as the price of beef continued to rise.

But if cattle futures had dipped, even slightly, during her initial trades, her entire investment could have been wiped out. In fact, a few bad trades during Mrs. Clinton's less than two-year run cost her more than $22,500 in total, but they weren't nearly enough to deplete her accounts, and she ended up more than $98,000 ahead.

If the price of cattle had fallen, Mrs. Clinton might have been asked to put up more money, in order to raise the margin back to the minimum level. But if the market is unusually active, the exchange may halt trading in a commodity. That can happen several days in a row, during which the price of the commodity continues to fall. With no buyers to release the investor from her contracts, she could end up forced to pay far more than she originally invested.

Even in 1978, an initial commodity investment of only $1,000 was unusual, according to John Damgard, president of the Futures Industry Association, the major commodities industry trade group. "Today if you had $1,000 you would have a very hard time finding a commodities market adviser" willing to invest for you, he said. Individual investors are more likely to find minimum requirements of $20,000 and more, Mr. Damgard said.

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