Due Diligence Trip: John Valentine on the Road in Chicago and New York
History of the Butter and Egg Exchanges
by John Valentine, contributions from Genevieve Valentine

New York City and Chicago in the fall are a spectacular sight. The trees are changing colors, people are busily working, shopping, and taking their children to school. The atmosphere in these cities and their hustle and bustle always feels productive.

This fall, I went on what I would call my yearly East Coast due diligence trip. This trip entitled visiting with a group of Commodity Trading Advisors (CTAs), Institutional Trading Platform Specialists, and Compliance Groups. I feel it is my responsibility to be annually updated on all of the outside investment teams. This due diligence trip allows me to get better familiar with or obtain additional information on products that may benefit our clients and prospective clients.

In addition to a series of lunch and dinner meetings and educational workshops, I visited the Chicago Mercantile Exchange and New York Mercantile Exchange trading floors. Seeing and participating in the hustle and bustle of these trading floors is not only a fun experiences, it is also a good indicator of what is hot and what is not in the sector.

In Chicago, I spent time with Greg Avallon of Superfund, and John Conolly, associate director of market education for the CME Group. Mr. Conolly explained the trading floor as “20% boredom and 80% pandemonium.” The floor of the exchange was like watching a football game—you are bored during the time outs, but once the ball is in play it is full of action. Greg, John, and I toured the CME building, met with many CME associates, and discussed the evolution of the future and commodity industry. We discussed the buyout of New York Mercantile Exchange and how the upcoming acquisition by the Chicago Mercantile Exchange (September 2009) will affect the commodity and future markets. Greg Avallon and I discussed the cost reduction programs, order entries, algorithms, potential gold denominated product, custodians of the Superfund product, and “Why it is not a Hedge Fund?”

While in Chicago, I spent three days with CME’s Educational Division. I revisited CME’s marketing booklet and educational system, which is being used to educate countless brokers and advisors on risk management, the transparency of money, and managed futures portfolio diversification opportunities. CME’s managed futures marketing booklet covers the benefits of managed futures, how to lower portfolio risk and broaden diversification opportunities, and the importance of flexibility and discipline.

CME has a large portion of its business and education completed through a computerized platform. “The CME open outcry platform and trading floor systems are linked to the CME® Globex® electronic trading platform, which allows market participants to buy and sell whether they're sitting at trading booths on our Chicago trading floors, working at offices or homes thousands of miles away, or making trades during and after regular trading hours. At CME, some traders prefer face-to-face interaction on the CME trading floors while an increasing number prefer to trade electronically” (www.cme.com) . I liked being able to work with and review products from this computer system. CME’s electronic trading platform is a useful technical tool.

In New York, I met with Bill Lynn, Vice President of Bridgeton Global Investors, Bob Lerner, Chief Executive and President of Ruvane Funds Management Corporation, and Phil Yang, Trade Advisor and President of Willowbridge Associates. Bill Lynn, Bob Lerner, and I discussed the business of the funds, investor communication, and the outlook of the future and investment markets. We even went as far as discussing the marketing, accounting, who their accountants are, and product procedures for Ruvane. I feel anyone can read a prospectus, but it is my responsibility to know the ins and outs of not only the fund, but also the business as a whole. Phil Yang over dinner at the Four Seasons (no relationship to the hotel) shared with me his investment methodology and philosophy, viewpoint of risk management, and global overview of the commodity and future markets. This microeconomic picture was useful and meaningful dialogue.

Bill Lynn and I reviewed the importance of William Sharpe’s work. For those of you who don’t know the legendry William Sharpe, 1990 Nobel Memorial Prize in Economic Sciences winner and professor at Stanford University. “William F. Sharpe is the STANCO 25 Professor of Finance, Emeritus at Stanford University's Graduate School of Business. He joined the Stanford faculty in 1970, having previously taught at the University of Washington and the University of California at Irvine. In 1996, he co-founded Financial Engines, a firm that provides investment management and advice for individuals in employer-sponsored retirement plans. He currently serves on its board” (www.wsharpe.com).

William Sharpe was on the originators of the “Capital Asset Pricing Model, created the Sharpe ratio for risk-adjusted investment performance analysis, contributed to the development of the binomial method for the valuation of options, the gradient method for asset allocation optimization, and returns-based style analysis for evaluating the style and performance of investment funds” (www.wikipedia.).

Modern portfolio theory shows how Sharpe’s economic philosophies are accomplished through investment strategies utilized through Welton and Willowbridge products. In fact, William Sharpe and Pat Welton, the co-founder of Welton Investment Corporation and fund manager for the RFMC Global Directional Fund, taught at Stanford at the same time. Welton oversees the firm's trading and research efforts, and is the senior management reviewer of all risk management reporting. He has been active in futures, options, and equities market research since 1981 and was an NFA Board of Director from 1997-2000.

Also while in New York, I revisited with Paul Wigdor, the COO of Superfund for two days. Our meeting was a follow up to our February due diligence trip. Wigdor provided detailed discourse on why Superfund selected new custodians for their products and the importance of the transparency of money. Superfund currently has four clearing brokerages: ADM, RBC, New Edge, and Barclays. This is for complete transparency. I even asked to review holding positions, trades, in order to see complete transparency. We reviewed Superfund’s new global expansion, marketing efforts, commercials, operational procedures, compliance process, and why Superfund is not a hedge fund.

With Wigdor, I was privy to revisit a DVD meeting between Superfund CEO Christian Baha and Harry Markowitz, which we original viewed in February of 2008. Harry Markowitz is probably the greatest economic theorists in the last 50 years. He is “best known for his pioneering work in Modern Portfolio Theory, studying the effects of asset risk, correlation and diversification on expected investment portfolio returns” (www.wikipedia.com). Markowitz won the Nobel Memorial Prize in Economic Sciences in 1990 while a professor of finance at Baruch College. Markowitz stresses the importance of mathematics and portfolio management. He proposed that “investors focus on selecting portfolios based on their overall risk-reward characteristics instead of merely compiling portfolios from securities that each individually have attractive risk-reward characteristics” (Theory and Practice of Investment Management, Fabozzi and Markowitz, 20020). Markowitz’s main premise is that inventors should select portfolios not individual securities.

After processing and accessing the business portion of this trip, I thought it would be useful for our clients to know exactly the history behind these exchanges. It is fascinating and worthy information. These exchanges are rich with history.

The Butter and Egg Exchange:

In 1898, the Chicago Butter and Egg Board was founded. This entity, rooted back to the early 1800s, was designed to help merchants exchange products. It would have looked like a contemporary farmer’s market. Farmers and buyers pushing carts full of vegetables, grains, and flowers. Literally, butter and eggs were being exchanged. In fact, when originally established in 1898, this board held only two contracts. You guessed it? Butter and Eggs.

In 1919, the Chicago Butter and Egg Board was reorganized, institutionalized about became the Chicago Mercantile Exchange (CME), the name it still holds. Once this reorganization occurred that is when the exchange began to trade future contracts and option contracts on over 50 different products, which consisted from pork bellies to soybeans.

“CME created the world’s first financial futures contracts by introducing futures on seven foreign currencies in May 1972. The original currency contracts included CME® British pounds, CME Canadian dollars, CME Deutsche marks, CME French francs, CME Japanese yen, CME Mexican pesos and CME Swiss francs. Today, CME’s currency market is the world’s largest regulated marketplace for foreign exchange (FX) trading” (www.cme.com).

The Chicago Mercantile Exchange started as a non-profit organization, which became a public hold entity in December 2002. “The road to this initial public offering began in June 2000, when Exchange members voted overwhelmingly to transform the then not-for-profit, membership-owned organization into a for-profit, shareholder-owned corporation” (www.cme.com). Chicago Mercantile Exchange was the first U.S. financial exchange to be publicly listed. Its ticker symbol is CME. In 2007, CME merged with the Chicago Board of Trade and became a part of the CME Group, Inc. And on March 17, 2008, the New York Mercantile Exchange (NYMEX) accepted an offer from CME Group to purchase it. The acquisition was formally completed on August 22, 2008, and the NYMEX systems are expected to be fully integrated by September 30, 2009.

The New York Mercantile Exchange:

When most people think of exchanges in New York they think of the New York Stock Exchange and the CNN image of chaos, yelling, and stress. Although that is true image for the NYSE, it isn’t true for the New York Mercantile Exchange. The NYMEX is the mellow New York trading floor. It is full of computer screens, traders aren’t yelling out trades, but walking from commodity station to station or simply calling the trader on the desired commodity. It is very smooth running operation. Do not get me wrong, I am certain the NYSE runs smoothly, but it does have a different sense of intensity.

Despite, the smoothness of the NYMEX and its interesting background, my fact part of the New York Mercantile Exchange is its view. You literally walk off the trading floor into a room that has the most beautiful view of the Statue of Liberty. You can’t help but get this sense of the original American dream. People trading futures, exchanging goods, while still having the image of hope at hand. It is a really moving picture.

The NYMEX wasn’t originally however in this location. It moved to this site in 2001 after the attacks of 9-11. The original headquarters and trading floor was destroyed in the September 11, 2001 terrorist attacks on the World Trade Center.

Like the Chicago Mercantile Exchange, the New York Mercantile Exchange has its roots in Butter. The difference was the New York started with Butter and Cheese, instead of eggs. My niece asked me, “Uncle John, do you think if CME and NYME would of merged back when the exchanges originated that we would of have had the New York Omelet Exchange. I thought that was clever. Little did she know that is almost exactly what happened.

By the late 1800s, marketplaces had sprung up at ports, parks, neighborhoods, and railroad stations all around New York. In 1872, a group of Manhattan dairy merchants got together and created the Butter and Cheese Exchange of New York. Soon, the egg trade became part of the business conducted on the exchange and the name was modified to the Butter, Cheese, and Egg Exchange. In 1882, the name finally changed to the New York Mercantile Exchange when opening trade began to conclude dried fruits, canned goods, and poultry.

As transportation improved and commodity warehouse were centralized warehouses, fundamental market exchanges grow and smaller exchanges disappeared, thus making the smaller cities exchange with the larger cities. The two remaining or fruitful exchanges were New York and Chicago.

In 1933, the COMEX, a division of NYMEX, was established through the merger of four smaller exchanges; the National Metal Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange, and the New York Hide Exchange. Thus, the New York Mercantile Exchange was not only trading raw material, oils, and gases but also medals. Today, the New York Mercantile Exchange handles billions of dollars worth of energy products, metals, and other commodities being bought and sold on its trading floor.

“The New York Mercantile Exchange, Inc., is the world's largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals” (www.nymex.com). In fact, in 1978, NYMEX forged the expansion of energy futures and options as a means of bringing price transparency and risk management to these markets.

Now, like mentioned before, CME and NYMEX will be successfully merged by September 2009. Once this merger is complete, New York Mercantile Exchange will be the last Butter and Egg Exchange remaining.

Moral of the Story:

My due diligence trip to Chicago and New York was to update me on the aforementioned commodity investment sector, but it also gave me the renewed experience of the rich history of these exchanges. I am proud to say that I was able to walk on the trading floor of these exchanges, while being able to see the Statue of Liberty through the fog. Each time, I walk into my local farmer’s market, I will think back to the time when Chicago and New York, the great cities and exchanges, looked just like this—people exchange not only goods, but their time and hard work. It puts life into perceptive. It is always important to have diversification and balance in life and our portfolios.

*Valentine Capital Asset Management is an SEC Registered Investment Advisory Firm doing buiness in the State of California. John Valentine, Founder and President.

*Securities offered through Securities America, Inc., member FINRA/SIPC. John Valentine, Registered Representative.

*The opinions and forecasted expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan.