U.S. commodity markets have shrunk almost 9 percent since MF Global's collapse as farmers, investors and traders close out positions, according to a Reuters analysis of data that suggests there may be lasting effects from the industry's most disruptive broker failure.
While several different factors likely figured into the decline - including the seasonal year-end closure of trading books - the study provides the first evidence to show that smaller-scale traders who were MF Global's core customers may have been effectively frozen out of the markets.
It does not yet answer the bigger question: how many of these traders will return to the markets? Their capital may eventually be fully restored in the bankruptcy process as lawyers and regulators search for up to $1.2 billion in missing customer cash; their faith in the system may be harder to mend.
"You figure that the company at MF's height was one of the largest non-bank clearing firms in the world and they had a large chunk of the business," said Richard Ilczyszyn, a former MF Global analyst who is now chief market strategist and founder of iitrader.com LLC, a futures commodities broker in Chicago.
"People got iced out of the market, it's paralyzing."
In the six weeks since the bankruptcy of the most active broker in U.S. commodity markets, traditional hedgers - including physical producers, consumers and traders - have closed out positions in corn, crude, gold and other markets, causing the number of open trades to shrink dramatically. By contrast, big hedge funds and speculators remain as deeply invested as before the collapse, albeit with positions that indicate they are much less bullish on prices.
In the week ended Nov. 29, open interest - a measure of market size that represents the number of active futures and options contracts in circulation - fell below 10 million contracts for the first time since July 2009, according to Reuters calculations based on Commodity Futures Trading Commission futures and options data from 19 key markets.
A drop of 1.3 million contracts in the four weeks following MF Global's collapse was the sharpest such reduction in positions since November 2010, when prices slumped. Interest has marginally risen since the low last month, but is still about 1 million contracts, or 8.7 percent, under Nov. 1 levels, and down 3 million contracts from a peak in February.
COULD BE TEMPORARY
The collapse of MF Global, which had been the most active broker on New York's metals and energy exchanges and No. 2 in Chicago's agricultural markets, has knocked confidence in the commodity futures market, in particular in the biggest U.S. futures exchange operator CME Group.
Indications the broker dipped into customer funds for its own purposes - an unprecedented violation of a fundamental tenet of the markets - shocked and dismayed counterparties who regularly leave millions of dollars in broker accounts.
The painfully slow unwinding of MF Global's customer accounts has been almost equally devastating. So far only 72 percent of $5.5 billion in so-called segregated customer funds has been marked for return. Money managers have spent much of the past six weeks attempting to shore up clients' confidence.
"(Clients) are asking questions like: 'Why should we trade if this is going to happen,'" said Ron Lawson, partner of LOGIC Advisors, a commodity investment firm.
Many trading positions that were moved from MF Global to new brokers required additional collateral. As the new brokers issued margin calls, some traders in markets like coffee were forced to liquidate, market sources have said.
"A great deal of the open interest left the market during the forced liquidation of (MF Global) customers due to unfortunate margin calls," said Hector Galvan, senior market strategist for brokerage RJO Futures in Chicago.
And other factors are also at work. Open interest has fallen steadily since earlier this year, with many investors and hedgers forced to the sidelines by unprecedented volatility.
Data for the past five years show a trend toward closing out positions in November and early December, when many funds wind down activity for the year.
The drop in activity may yet turn out to be temporary. While many traders have written off the year or are still waiting for their remaining funds, some investors are already making a tentative return. Even so, many fear that some traders - once burned - will be doubly shy of returning in force.
For farmers, that could mean hedging less of their grains or livestock; for speculators it might mean instead trading securities such as exchange-traded funds, which offer brokerage guarantees, or even buying physical assets such as bullion.
"We've had a lot of people getting out of the financial products and into the physical," said Lawson. "People are just not sure anymore if their futures contracts are as good as they appear to be."
DATA SHOWS DEPARTURES
A breakdown of the data suggests those participants hardest hit were also MF Global's prime customers.
The Producer/Merchant/Processor/User category - companies that produce, consume or trade the physical commodity - cut open positions by some 623,000 contracts since Nov. 1, a drop of 10.4 percent, based on the sum of both long and short positions.
And the "others" group - small speculators, industrial firms or other traders - cut positions by nearly 700,000 contracts, or 14 percent of their total, largely by closing out spread trades rather than eliminating long or short trades.
"(The data) speaks to the profile of MF Global customers," said Ralph D. Preston, market analyst at California-based CTA, Heritage West Financial Inc.
One group in particular hasn't significantly reduced its exposure to the market: the hedge funds, CTAs and other big speculators who make up the "managed money" category.
They have pared holdings by just 111,000 contracts or 2.4 percent, based on calculations from CFTC data. As a result, speculators' share of the market has risen to the highest since March 2010 at more than 22 percent of open interest.
The largest markets were predictably those hardest hit.
In CBOT corn, open interest fell by some 636,000 contracts, or 17 percent, from Nov. 1. NYMEX crude oil suffered the second-largest decline of more than 470,000 contracts, or 9 percent.
Open interest is only one measure market health though. Trading volume - viewed by many as better gauge of participation - doesn't appear to have suffered unduly, separate data show.
In November, overall energy futures trading volume - which makes up more than half of all commodities trading on the CME's four main exchanges - rose 16 percent from the previous year. Metals futures fell 25 percent from November 2010. Chicago's benchmark corn and wheat contracts saw modest monthly declines, but big gains compared with October, highlighting volatility.
Many say that even before MF's meltdown the outlook for traders had grown bleak as prices gyrated on euro zone concerns.
Commodities giant Cargill is cutting staff, and French banks are reducing their U.S. commodities trading due to the crisis.
For some, broker distrust is simply one more reason to steer clear.
"Everyone is concerned more people will get out of the business in 2012, spec money is moving to the sidelines, it's getting worse because there is a lack of trust," said Matt Pierce, an analyst for GrainAnalyst from the CBOT floor.
Others hope that efforts to restore confidence will eventually succeed, but the healing process could take longer than the average crop cycle.
"When you give the industry a black eye, a lot of people start pulling back and start to walk out of the market," said J. Mark Kinoff, president of Ceres Hedge, a CTA and a hedging consultancy firm in Chicago.