September 9, 2022
Last week, I began a series of articles describing some of the hedging blunders I have seen over the years. By definition, a hedge is a market position in a market off-set by opposite position in different market. Often, what starts out as market risk reduction program becomes a very high stakes speculation position.
In 1988, I had four farmer clients with a hedge line of credit. Annual future prices ranges were small. The farmers, their banks and I had all agreed that the bank would finance margin requirements up to $4 per bushel for beans and $1.50 for corn.
The agreement was the four different banks would transfer funds by wire from the clients’ hedge line of credit directly to the clients’ hedge account and the brokerage firm would automatically transfer the bank excess funds when available.
The drought of 1988 really started in the middle of July 1987. Autie called me April 24 of 1988 to tell me he was all done planting corn and beans. By mid-May, temperatures were frequently in the mid to high 90’s. The first week of June, we saw 100+ degrees become routine. Unlike the 2012 drought, the humidity was very low and sucked the moisture out of the soil and every living thing.
The price of corn had been below the cost of production (about $2.25) since the 1983 drought.
On June 17, December corn traded above $3.25. The farmers locked in $1 per bushel profit, a windfall profit in those days.
Since there is no requirement for delivery on futures contracts, a high percentage of a normal crop yield was hedged by all four farmers – almost a half million bushels. If they did not grow the bushels in 1988, they would in 1989. The margin money was transferred just as it should have been every day. By the end of June, corn fields looked like pineapples and had gone dormant.
The 4th of July provided a 3-day weekend in 1988. It was July, the month the corn crop in the Corn Belt is made or lost. It was make or break time for the corn crop and there was no rain in sight. Every farmer in America would have taken a 45 bushel corn yield if one could guarantee it. In those days, the CBOT started trading at 9:30 a.m. Chicago time.
The farmers and I learned on the morning of July 5 that all four banks had not made the margin calls issued the previous business day, July 1. Since corn futures were going to open sharply higher and because the banks had failed to transfer the money as agreed on Friday, the brokerage firms were going to liquidate all the short corn positions on the opening because the margin calls had not and were not going to be met.
When a futures account is opened, that is one of the things covered in the fine print. It is a necessary step to preserve the financial integrity of the futures markets.
The expectation of an event will move the market more than confirmation of the event. And so it was in 1988. The high for multiple years was made on July 5 at $3.70, even though the poor crop was not confirmed until Aug. 10. All those hedge positions were bought back (offset, liquidated) on the high day that would not be exceeded for eight more years. None of the hedge lines of credit had used even 30% of the approved credit limit.
Why did the banks pull the plug? “We loan money to hedge corn and beans. With this drought, there won’t be any corn and beans. Therefore, those hedge positions are speculative and we don’t finance speculation in the futures market.”
It was uncanny how all four banks, supposedly independent of each other, came to the same conclusion on the same day. When people change their marketing plan while under severe emotional stress, it is a reliable indicator and a characteristic of markets making a top or bottom.
December corn was down to $2.48 late that fall, $1.22 below the July 5 high. That meant the farmers lost 45 cents in the hedge and would have been selling corn for less than a net of $2.20 with the basis. A total disaster with the short crop of 88 bushels per acre, 70% of normal yields.
Fortunately, those farmers netted their hedge price because, as their hedges were being liquidated at the highest price traded between 1983 and 1996, their grain merchandisers were selling every one of those bushels on HTA contracts. I never loved grain merchandisers more than I did that day, July 5, 1988.
Read more from this series:
Wright is an Ohio-based grain marketing consultant. Contact him at (937) 605-1061 or [email protected]. Read more insights at www.wrightonthemarket.com.
No one associated with Wright on the Market is a cash grain broker nor a futures market broker. All information presented is researched and believed to be true and correct, but nothing is 100% in this business.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.
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