Everyone in the world of grain – especially farmers – has been slapped upside the head by the wildness of the crop markets in recent years. From the lows of the early 2000s through the sky-highs of 2008 to the following crash and recovery, grain and oilseed prices have been volatile.
How do you hedge for that volatility? There are short term, medium term and long term answers for that question. Here’s a medium-term answer from the Mexican grain buyer I met with Tuesday. He said speculators had made price swings big, and that this was now a fact of life. So what does he, as a grain buyer – living on the spread between what he buys wheat for and what he can sell bread for – do:
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“What can you do with the speculators? Nothing. Only we need to protect us. To take options. To have target prices. There’s a lot of volatility. (If) you put open orders in the market, normally you (will eventually see the order filled). You only need to be patient. Months before you receive your vessel you can take position of the price that you need to meet your budget target.”
Sounds pretty sensible to me, and as if he has a marketing plan, which he does.
“You see high prices. You see low prices. Everything that goes up comes down. You need to be patient and have a good strategy.”
That sounds to me a lot like what most farm marketing advisors say: figure out the prices you need to make a reasonable profit margin, then start picking away at sales. You’ve got to base it on what’s actually possible in the market environment that year – and cost of production has little to do with price in the short term – but by knowing what are reasonable prices, at least a marketer can know when to consider moving into sales or purchases.
The problem with this approach, of course, is that it only really applies to volatility within a range. If everything that goes up predictably comes down, and goes up and down a bunch, then this strategy works. But what if prices are moving into a new long term high, or low, range? Then your expectation of prices naturally returning to where you expect them to return could be way off, and in a falling market a patient seller could find himself patiently sitting on a downbound train heading towards the bottom of a canyon. A buyer in a rising market could find himself hanging on for a return to lower prices that never comes, and like that Greek guy that flew too close to the sun, end up flapping featherless towards the sea.
That’s why I liked the word “options” that he used above. I don’t think he was referring to call and put options, but those are what are ideal to use in hedging strategies for unpredictable times. You can take a position, not be locked into the price, but at least have something as an insurance policy. But how many people use options? Not many. So we’ll always be complaining about volatility, because we don’t prepare for it.
