Volatility in grain prices and almost everything else these days must have many farm managers thinking about ways to lessen their risk.
Futures markets provide the tools to hedge grain, livestock and currency risk but many farmers still are a bit hazy on how to use them.
Richard Wiese of Top Step Trading provided a primer on hedging at the Agri-Trend forum last week in Saskatoon.
Confusion arises from the fact that there are two types of players in the futures markets, hedgers and speculators. The latter are gamblers and their high profile leads many to think futures are a risky venture. But hedgers are in the market to lower their risk, Wiese said, and that is an attribute that interests farmers.
Read Also
China’s grain imports have slumped big-time
China purchased just over 20 million tonnes of wheat, corn, barley and sorghum last year, that is well below the 60 million tonnes purchased in 2021-22.
The farmer-hedger’s goal is to protect a price at which he can make a profit, based on his cost of production.
A futures contract sets out the price today of buying or selling a commodity in the future. Options, called puts and calls, are related tools.
The hedger uses the futures market to guarantee a price in the future even though the cash market might rise or fall in the meantime. The cash and the future markets work together to provide the final revenue.
The producer still sells the physical commodity on the cash market. If the cash price falls, the futures contract provides the revenue to raise the return to the contracted price.
If the cash price rises, the futures contract registers a loss, offsetting the cash rise, but the cash and futures combined deliver the price that was contracted.
That is why it is critical to know your cost of production. If you know that cost and use futures to lock in a price higher than the cost, you lock in a profit.
When measuring the performance of a hedging program, Wiese said the hedger should not think he must beat the market. A negative balance in a hedging trading account is not necessarily a bad thing because the loss could be more than offset by the gain in the cash market.
Also, a hedging program should not be influenced by the farmer’s view of the market and expectation of price direction The hedger should operate on the assumption that markets are inherently unpredictable.
“A hedge is never a gamble on the direction of market prices,” he said.
Wiese also noted that hedging part of a crop in the spring could be a wise move over the long term. The period before seeding often provides the strongest markets of the year because of worries about year-end stocks and potential weather problems.
Farmers spend a lot of time educating themselves about crop protection products, crop management and machinery to get the most from their land. Learning about hedging is no more difficult and can provide the tools to lower risk and improve the farm’s bottom line.
