The Cure For High Commodity Prices: Hedging | MartinKronicle - Michael Martin
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The Cure for High Commodity Prices: Hedging

march.corn

March Corn (click for larger picture)

Didn’t the US Government pay farmers to NOT grow corn? That was quite a gamble, especially since they don’t allow for sugar ethanol. Now the food companies and the ethanol producers are jamming up the prices on American consumers.

Had they hedged, they could have passed the savings on to consumers, just like Southwest Airlines did from their effective fuel hedges during peak oil. By not hedging, food companies are in effect gambling that prices for their raw materials will stay within a range. But when scarcity hits the tape, they can blame speculators (whatever that means anymore) and push the costs off on consumers in order to protect their profits. They can do this by increasing prices, or by decreasing the size of the containers they sell the food in and keep the prices the same. You get less food for the same price, hence an increase in food prices.

What the food companies do is gamble that their competitors won’t hedge either, an extremely reckless way to run a business. If the prices go up, none will look so bad as all the firms will have to raise prices. In the meantime, the large space under the curve when things are “normal,” food companies can jack their earnings higher by saving the insurance money they would have used to hedge.

When your compensation is in stock, you’ll whore out your balance sheet and income statement to get the stock price as high as possible. I believe that they are gambling their company for the sake of their Executive Compensation plan. Myopia, USA.

An article in Agrimoney.com stated that “corn and cotton are to win this spring’s battle for acres on US farms, enjoying hefty increases in sowings, US officials said in a report forecasting crop prices would stay “historically high” for at least a decade.”

march.cotton

March Cotton (click for larger picture)

Hmm, more forecasts…I love it. High prices for the next decade. I guess that means for all the new plantings, there will still be insufficient crop surplus to drop the prices of at least corn and cotton. The unnamed US officials must have a line on the US dollar then…that must be the cause for high commodity prices going forward the next ten years. These people are f’n talented man…people of vision. Sir Richard Branson should be looking to recruit his successor from this lot for their vision.

Farmers rush to plant crops of the highest price commodities so that they can potentially earn more $$$ from their farmland. But it’s not a science per se, they have to account for the fact that every crop has its own unique costs.

If the farmers over-correct and create a bumper-crop…a giant surplus…the prices of the commodity drop very fast. Therefore, it is said, that high prices are the cure for high prices. Farmers can use futures or options on futures to lock in the higher sell prices long before the crop is ready for harvest. Food companies can use the same tools to lock in lower purchasing costs.

American CEOs who don’t hedge are the real gamblers in the commodity markets. Not having an effective hedge on is still a position in the market.

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  • hukers

    HISTORY SAYS THOSE PRODUCTION COMPANIES THAT TRIED TO HEADGE LOST EVERY PENNY

    AS LONG AS THEY DO WHAT THEY SHOULD IE PRODUCTION THEY SURVIVE
    AT THE MOMENT THEY START SPECULATING THEY TRANSFORM TO BROKERS AND THEY IN THE END LOSE EVERYTHING

    IF YOU DO NOT UNDERSTAND THIS, YOU ARE…

  • Anonymous

    This is a statement – a generalization – without any support. “Lost every
    penny…?” Hedging means they are long the physical and short futures or
    vice versa.

    Consumers lose lots of pennies when producers or users of commodities don’t
    hedge. These firms then pass off higher costs to the end user, which is the
    point of my blog post. Higher prices can be offset to a great extent as
    there is no single, perfect hedge.

  • hukers

    in my country exporters headged against weak euro in first half of 2008 , some went bankrupt, some restructurised debt against banks

    biggest oil rafinery headged against rising oil price, they do not have own petrol oil production so they headged to secure profits

    oil went to 145 and dropped to 35, they lost 1,5 year profits
    now they use bigger margin then usually because they have to quadruple profits to erase previous loss
    so we pay more at gas pump
    last quarter they had all time high profits what proves that they increased margin

    I gave you an example , if company headges and loses money then ordinary people has to cover their losses
    they woulod be better off not to headge but to refine oil as their basic oparation is

  • Anonymous

    Hukers, you mean “some” exporters might have used incorrect analysis in
    hedging the Euro, right? You don’t mention the hundreds or thousands that go
    it right.

    Refiners trade the crack spread, which is a hedged position unto itself, so
    there is less risk.

    Further, hedgers have much lower margin requirements for their positions
    than investors so for the same trades. The market rules, and the markets
    themselves, are built around benefiting hedgers.

    You probably won’t hear from the hedgers who go it right. You’ll see the
    folly of humans who think they can predict the markets and place their
    hedges accordingly.

    Users or producers of commodities should heed my advice: forget your
    fundamental analysis and hiring MBAs and CFA types — they are not traders
    nor risk managers. Hedgers need market timers.

    Recruit and hire the best traders in your space from a hedge fund or prop
    desk and pay them well in cash and stock.

  • Muhammad

    Hi Martin

    IMO large corporations paying huge $$$ to CFA/MBA types are looking to predict and outsmart the markets with fundamentals only is analogous to using a crystal ball.
    Without an exit strategy there can be a world of pain and usually is

  • Anonymous

    Yes, and when you marry that with the fact that humans are horrible at best
    at predicting anything, you have a recipe for destruction.

    When you consider this further along the line that humans are poor at
    predicting the size and magnitude of outlier events, the destruction is a
    matter of “when” not “if”.

  • Vvsera

    By the way, can you  help explain where have all the profits made from sales of commodities gone to, since commodities price have gone up so many times in the past years and the high profit sold from them..    

  • Anonymous

    I think you might be confusing high prices and potentially high sales revenue with profits.

    If there are high profits, they’re likely to be reinvested or distributed to retirees who need the money. Pensions and endowments are the largest investors in commodities.

    Profits can be reflected in earnings per share for publicly traded commodity firms.