March 15, 2022
Last week I spent some very enjoyable time down in New Orleans attending and presenting at Commodity Classic. I learn so much from talking to people in person. Thanks to all for stopping by our booth to share your time with us. We held many great conversations.
Price action was a hot topic, as we are experiencing incredibly high volatility and big price swings. If wheat doesn’t trade up or down 30 cents each day, it feels as though it’s barely moving. This market action began 19 months ago and nobody can say when it will end. Nobody.
Prices will eventually turn lower, but will this happen next week or next year? It can’t be predicted. If history repeats itself from past higher price years, the break will happen significantly faster than the price increase has.
One of the realities of huge price swings is bad pricing decisions become much more amplified. Many have heard the stories of farmers who pledged bushels into a managed marketing pool and are receiving prices much below current levels. I’ve had some farmers tell me their current prices are near the very lows of corn and soybean price ranges. How does this happen?
A short answer could be a lack of knowledge and respect for the history of price volatility. In my early years at Advance Trading, I worked with a man who talked about an episode with a firm called Cook Industries. The firm collapsed in 1978 due to large speculative positions in the soybean market. Cook apparently stopped focusing on price management and hedging and turned their firm into one using speculative positions, costing the company millions. As I was told, old crop/new crop spreads were a large part of this fiasco.
This story impacted me greatly in the early stages of my career. It paid dividends over time as it was a healthy reminder to focus on reducing risk, not increasing it. History repeated itself in 1995-96 with the multiyear hedge-to-arrive crisis. An entire book could be written on this, but simply put, farmers were encouraged to price up to 3 years of production in 1995 futures with the intent of rolling these into the proper years over time. Long story short, the old crop/new crop spread ended up around $1.50 inverted and when subtracted from approximately $2.80 futures, it left the farmer with $1.30 before basis.
This wasn’t hedging -- it was speculation.
I remember a presentation at the Country Elevator Council in St. Louis in 1995 where a broker was laying out that recommendation. He said, “It’s not often futures trade above $2.80 in December futures.” Then he added, “Most of the time you can roll the old crop futures sale to new crop at a credit.” Someone in the audience asked him, “What if this is the year we can’t roll the spread at a credit?” It was another example of the lack of knowledge and respect for price and old crop/new crop spreads.
2008 and 2012 were years with higher prices and plenty of stories of low sales. Some were just simply farmers on their own doing this, and some were from managed bushels.
We’ve all heard, “If it sounds too good to be true, it is.” We have also heard, “There are no free lunches.”
Managed pools, and I know this doesn’t represent all of them, have become very aggressive with the tools to favor better results in lower price years. The reason for this is the use of short options to help finance the cost of the long option or a floor price. Then some are adding pieces that have the net effect of doubling up the bushels pledged and therefore doubling up the risk and loss of pledged bushels.
I could teach an entire seminar on the history of pricing disasters. Let me sum it up this way: History repeats. History matters. Inexperience shows up more in big price range years. People hedging futures in the wrong crop years are speculating. If you are a young trader who is managing bushels on behalf of the farmer, I urge you to talk to a “veteran” risk manager and ask them what bad stories they can share in years such as 1978, 1995, 1996, 2008 and 2012, for starters.
In those years, good risk managers added tremendous value to their clients. You must take advantage of these types of markets. It is inexcusable to not be able to benefit from higher prices due to speculating on price.
If you are a grower and are not cheering for higher prices, something is wrong. Please let us know if we can help you navigate the next steps if you are not enjoying higher prices due to a poor marketing plan.
Contact Advance Trading at (800) 664-2321 or go to www.advance-trading.com.
Information provided may include opinions of the author and is subject to the following disclosures:
The risk of trading futures and options can be substantial. All information, publications, and material used and distributed by Advance Trading Inc. shall be construed as a solicitation. ATI does not maintain an independent research department as defined in CFTC Regulation 1.71. Information obtained from third-party sources is believed to be reliable, but its accuracy is not guaranteed by Advance Trading Inc. Past performance is not necessarily indicative of future results.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.
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