How do you handle opposite takes on where a market is going to go?
Here’s a quote that should be kept in the front of every hedger’s mind:
“The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still be able to function.”
That’s from William Falconer, an 18th century Scottish poet.
If you’re hedging crops or livestock, you need to keep apprised of the markets and listen to market outlooks from a variety of sources.
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You will almost always encounter opposing outlooks, to which there are two responses: go with one and ignore the other, or keep both in mind and hedge. Here’s an example that could cost you money in the next year: currency exchange rates.
Where will the loonie go compared to the U.S. greenback?
Not only do market commentators have opposite views on that question, but many farmers will be more exposed than ever to foreign exchange risk.
First to the additional risk: many farmers will be tempted to use Minneapolis Grain Exchange hard red spring wheat futures contracts to hedge their wheat this spring and summer. Grain company contracts are sparse and risky right before the crop is in the bin and the grade and quality are known. Futures offer a way to lock in a general wheat complex price, leaving just basis exposure to grade and location. But there is also foreign exchange risk, because the MGEX contracts are priced in Yankee bucks, not Canadian dollars.
Thousands of farmers have for years hedged canola prices using Winnipeg futures priced in Canadian dollars. Hedging wheat with MGEX futures brings foreign exchange risk.
Now to the polarity of currency market outlooks.
Market outlooks are always divergent: sometimes it’s by a few degrees and only occasionally by huge amounts.
There are currently two extremes of market opinion about what will happen to the U.S. economy, and they’re not restricted to the fringes of analyst opinion. Many analysts hold middle-of-the-road views, but that’s not remarkable. What’s interesting is that radical opinions are held by many non-radical analysts.
One group, the inflationists, believes the oceans of debt-based money that the U.S. government is creating to stimulate the economy will create hyperinflation and that the value of the U.S. dollar will collapse. The recent signs of growth and recovery in the U.S. economy encourage this belief. Inflationists also expect European governments to find tricky ways to eliminate their debt that will also have currency-degrading effects.
On the opposite side of the debate are the deflationists, who believe the world’s critical economic and financial problems have been suspended only temporarily and will soon return in full force. There are early signs of a hard landing in China, the United States is still shackled to a mountain of debt and Europe is staggering under the weight of government debt and near-depression in Mediterranean nations. As a result, the value of assets will likely fall and the value of money rise.
As well, the U.S. dollar could surge again if there is another “flight to quality,” as it does everytime the world gets worried.
So inflationists fear a rapidly rising loonie (at least compared to the greenback) and deflationists fear a rapidly falling loonie.
How do you hedge for both? Well, you hedge. If you lock in a crop price, and lock out currency volatility, you’re hedged on most of your exposure.
That’s what many advisers always suggest.
But now is a time when it’s more important than ever to consider locking out that currency risk. If you lock out the risk, you don’t need to worry about contradictory outlooks, even if you can function with them both in mind at the same time.
