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Multiple-year hedges - How can I lose?

Agriculture.com Staff 07/17/2008 @ 8:48am

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.

The 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 generation).

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!

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