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We hedge because nobody knows the future

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Learn to hedge by watching how grain merchandisers manage risk.

The saying goes: knowledge is power. That makes sense if the knowledge you are gaining is real. Being told, “corn must go higher because we have dropped so much already,” or “USDA is way off on their acreage estimate so prices will move higher,” is not knowledge. These are opinions and you cannot afford to pay the price when they are wrong.

It’s human nature for the grower to believe prices will move higher and for the end user to believe prices will move lower. Often, both groups have these beliefs because this is what they need to have happen to thrive, and in today’s world, to survive.

It’s normal yet it’s also problematic if you are only listening to those who only share good news.

Outside voices

To avoid being hurt by lower prices let’s begin by surrounding yourself with outside voices who won’t always tell you what you want to hear. Do you have people in your life willing to ask the hard questions and disagree with you? It’s healthy to have someone to argue with as to why you have not managed price.

When this year started you weren’t hearing from anyone about a Saudi Arabian and Russian oil price war and you weren’t focused on COVID-19. Yet these are the two most significant factors impacting prices in 2020.

While these events were damaging to grain and livestock prices, all too often there were voices telling you why prices have to rebound instead of helping you focus on price risk and seeing other scenarios. The next factors to impact price are not known at this time, and by the time they are known, price may react too fast for you, especially if you are not a hedger.

Learn from merchandisers

The role of the elevator merchandiser and the farmer are not the same, but we can learn a lot from the elevator when learning how to be a hedger for your farm.

When a country elevator purchases your grain, they are focused on basis and carry. If they see a return from these, they sell futures to offset their purchase of the bushels sold by their farmer client. If basis improves, they can sell those bushels and earn a return on their asset investment. They can also make a return on carrying grain in house via spread management.

They are not focused on flat price moving up and down as the grower would be. Most state laws have rules in place that insist elevators are hedged. This protects the farmer as well as brings confidence in the warehouse industry.

We don’t have these laws in place for farmers. You are independent in making decisions on the selling of your grain. It’s hard to imagine a merchandiser at the elevator having this conversation with his hedging broker. “Hi Bill, we just bought 50K bushels of grain from a client. What should I do with these bushels? Well the market sure has dropped significantly but I am seeing some things on my end that lead me to believe prices are ready to move higher so let’s hold off hedging (selling futures) for now.” Or how about this one: “let’s hold off placing a hedge today, I just don’t believe USDA has this crop size correct.”

This doesn’t happen because the risk is so significant, not to mention the grain and feed rules on hedging in place in most states. The above conversation does take place all too often with farmers who have flat price risk with the voices they listen to in managing price risk. Again, many tell you what you want to hear.

Being informed

We have a wonderful research team in-house and I enjoy reading all I can about markets and all news that impacts price in the world. However, being well informed on market fundamentals doesn’t mean a thing when it comes to predicting future market reaction. The merchandiser doesn’t allow the news or market action to go unhedged as long as they can earn a return to storage. I don’t believe anyone can capture enough news in order to figure out price direction.

If anyone attempts to convince you otherwise, I have to ask, why do they have a day job? Your chances to succeed in defending price will improve if you can learn how to be a hedger and not allow others to take you down the path of price prediction.

So, what does that mean for you? First off, let’s agree that you are in the business of growing and hedging the crops you raise. There are enough tools around that you can separate your dislike for today’s price vs. the choice to not be a hedger. Hedging doesn’t have to mean that you are locked into a price and are unable to sell at higher levels. If you aren’t sure how this works, we can educate you to understand this. Once you find yourself in this position you won’t be caught by surprise on future news that surprises the market.

Lastly, stop listening to anyone who has you selectively hedging based on their guess on price direction. Just because they bash USDA or tell you what you want to hear doesn’t mean you are being served. Hedgers don’t get worn down by adverse price movement. Those getting worn down are listening to someone who is predicting price, on your tab.

Markets don’t react to the news in your head. They will be impacted by future events not yet occurring. There is a better way to deal with lower prices and it starts with education and learning how the professional hedgers do business.

 

Contact Fogel at 800-664-2321 or go to www.advance-trading.com

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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