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Multiple-year hedges - How can I lose?
Occasionally there appears an intellectual article about hedging multiple years
of commodities when prices are good.
These articles were pushed in 1996 by some
intellectual types since prices got so high that year. The idea was to price a
fair amount of grain at $4 or higher corn, selling 2 or 3 years of crop for
these high prices as 'everyone knows prices won't stay there'.
University market analysts pushed this relatively hard in 1996, and that was the
start of the hedge-to-arrive debacle. Recall that July 97 futures were trading
at a 50c to 75c premium to Dec 97 futures - a historically large premium at the
time. Many elevators and farmers took these multiple-year hedge articles and
the large spread and combined them into a HTA strategy whereby they sold Dec 97,
Dec 98, and Dec 99 or more crop on the July 97 futures. They were speculating that
the spread between July and Dec97-Dec99 would narrow, and thus they would
capture that spread difference. Herein lies the problem: The spread went to
$1.50-$2, bankrupting many southern MN/northern IA elevators and farmers, and
the fingers were all pointing the other direction for who was at fault.
reality was they both were in hedging in the wrong months (not when they had the
grain), and speculating on a spread! Trading rules of speculators say you should
have gotten out when it was clear you were wrong (stops?)! But alas, many
farmers didn't even know they were speculating on the spread - what's the
difference as corn is corn, right? NOT! (translated WRONG for us older
In 2006, many more multiple-year hedges were discussed as new crop prices
screamed higher to $4 corn, $6 wheat, and $10 soybeans, so many sales were made
on multiple crop years at $3.50-$4.50 corn, only to see the market soar to $8
last month! Huge hedging losses piled up, and now elevators (and bankers) won't
let farmers sell grain at all in many organizations.
Now, it appears corn (and possibly soybeans) have topped out after a 2 year
surge in prices, and here we are offered $15 soybeans and $6.50 corn for the
next 4 years (2008-2011). Pro Ag finds it ironic that now when it appears we've
just had a 35-year rally in grains (from $2 to $8 corn, from $5 to $15 soybeans)
that everyone is afraid of selling anything. In fairness, input costs have
changed so dramatically that farmer fears are $6.50 corn in 2011 might be a
loss! Elevators fear that $6.50 corn hedges could have $4 of margin calls if
corn rallies like HRS wheat (recall that Feb. madness when HRS rose to
$25/bushel? Seems like an eternity ago now with HRS wheat at $10!).
We see no suggestions about selling multiple years of grains after a 1972-1974
type rally! WHY? The reasons are many, including: 1) Fear of margin calls,
2) Bankers won't finance anything as they deem it 'risky' after the past 2 years
experiences, 3) The only memories growers have is rising prices as they've risen
for 2 years straight, and 4) FEAR!
We challenge growers to look at what would have worked in 1975-1979 (selling
lots in June/July for corn/beans, selling wheat in Feb-April) instead of the
last 2 years (2006-2008) as prices dropped 20-40% into harvest of many of these
years. Also recall these years followed 1972-1974 - almost the exact same once-
in-a-lifetime 2 year rally like we've just experienced. By our calculations,
from $8 corn that is $3.20 break into harvest, with $16 soybeans a 20-40% break
is $3.20-$6.40 down. These are huge numbers, and likely given our recent crop
improvement in corn/soybean yield potential this could happen again in 2008.
This brings up a Pro Ag marketing rule: When you are afraid of hedging, that's
usually when you should be doing it. When you are anxious to hedge, that's when
you shouldn't do it. Remember at $4 corn, everyone was anxious to hedge
because it "can't go any higher". Now at $6.50 corn (and down $1.50 from highs
indicating a top is in), no one wants to sell! Think of the psychology of
selling at $4 vs. $6.50. At $4 in 2007, it's never been there so why not sell
it? At $6.50 in 2008, all the guys selling at $4 are licking their wounds while
the guys who did nothing are gloating they have $6.50-$8 corn (but you only have
it if you sell it). So nothing gets sold at $6.50 or higher, and most get
$4.50-$5 in the end at harvest! I talked to a MN banker this week about
multiple year hedges at $6.50 or better, and he called it "risky" and said he
"wouldn't want to be involved in it."
Pro Ag sees these multiple year hedges as offering little risk but lots of
reward today following a once-in-a-lifetime rally. These profits (even with a
50% fert/fuel annual price rise) are unbelievably high. I challenge any banker
or farmer to show me how a farmer can lose money selling $6.50 corn from 2008 to
2011 (email address firstname.lastname@example.org, put '$6.50 corn' in title). Ditto
with $14.50-$15 soybeans. If you've got the land secured and buy 70-75% crop
insurance, I'm having trouble showing a loss no matter what the yield, price, or
situation! As a risk management advisor and crop insurance/marketing expert, I
can't ignore what these numbers are telling me. How can that be risky, even if
inputs rise 50%/year? At current profit margins, there is plenty of room!
I must recommend sales of 2008-2011 corn/soybeans at $6.50+ corn and $14+
soybeans. Worst case scenario I see is for no crop and huge hedging losses and
a crappy basis. But still, crop insurance guarantees me huge profits. Am I
missing something? Best case scenario? I sell $6.50 corn today (also $15
beans), and buy 4 years of crop back in Nov/December for $4.50. And then sell
again next Feb-April for $6.50 again, and buy back again for $4.50 at harvest.
And do it over and over and over like the energizer bunny until other farmers
start doing it (when its easy to do and everyone is anxious to do it, don't -
see rule above)!
The information contained, while not guaranteed as to accuracy or
completeness, has been obtained from sources we believe to be reliable. The
opinions and recommendations contained are based on our judgement and do not
guarantee profits will be achieved or that losses will not be incurred.
Recommendations should not be construed as an offer to buy or sell
commodities. There is substantial risk of loss in trading futures and
options on futures.
Ray Grabanski is President of Progressive Ag, a marketing and risk
management firm for farmers located in Fargo, ND. For questions or
comments, or if you are interested in more information about Progressive Ag's
common sense marketing services, call 1-800-450-1404 or email
Occasionally there appears an intellectual article about hedging multiple years of commodities when prices are good.