—Lancaster Farming, Saturday, August 11, 1973
12
Hedging
(Continued From Page 1 )
ahead of the game. If the bears
are wrong, the farmer who
hedges will earn less than he
would on the open market The
reason for hedging, according to
many bankers and farm
economists, is the ability to
predict an acceptable level of
profit, even if hindsight reveals
that profit to be lower than it
might have been In the Midwest,
many farmers are able to borrow
money only because they
routinely lock in a profit by
hedging on the futures market
Locally, ag bankers say hedging
isn’t employed by very many
farmers as a management tool.
But they foresee the day when
more and more farmers will be
using it
Hedging isn’t something to step
into lightly, we were told by one
banker. It takes a lot of careful
thought, and a good record
keeping, system A farmer who
wants to hedge should arm
himself with as much in
formation as he can possibly get.
Eventually, the hedger winds up
talking to a commodities broker,
like Reynolds Securities in
Lancaster, or Rosenthal & Co. in
Allentown. To find out what goes
on in a brokerage office, we
visited the Rosenthal firm on a
recent market day.
One thing a visitor learns,
shortly after noon, is that com
modity brokers don’t eat lunch If
a man were to spend his entire
working career with a com
modities brokerage firm,
chances are good that he’d never
go to a business lunch.
From about ten in the morning
until after three in the afternoon,
all four brokers in the Rosenthal
office were on the phone talking
to customers and traders. They
constantly scanned TV screens
bearing the latest computerized
quotations from commodity
markets around the country.
Periodically, they read financial
news reports as they came in
over a teletype machine.
Firms like Rosenthal are
always busy on market days, but
lately they’ve been even busier.
Trading in commodity futures
throughout the country is at a
record level.
Since organized trading in
futures began in this country
more than 100 years ago, it has
passed through several periods of
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rapid growth. During the last
decade, both volume and the
number of commodities traded
have increased dramatically. In
certain years, the dollar volume
of trading on the Chicago Board
of Trade alone has approached
that of the New York Stock Ex
change Now, there are 20
licensed exchanges in the U S.,
doing business in the neigh
borhood of $2OO billion a year.
This impressive figure
represents the dollar volume of
all the commodities traded. They
range from soybeans and gram
sorghum to plywood, and they
have one thing in common: Those
speculating in them can make-or
lose--a fortune in a matter of
mn utes
This is the glamorous aspect of
futures trading-the ability of
speculators to make money by
playing the market But at least
as important is the businessman
on the other end, the hedger, who
uses the futures market to
protect himself against financial
loss.
A new study by the USDA’s
Economic Research Service
(ERS) took a look at hedging in
the livestock futures market.
What it found could encourage
more cattle and hog producers
interested in minimizing
financial risk this way.
The exchanges where com
modities are bought and sold
grew out of the need for advanced
sales by merchants who ac
cumulated farm stocks.
Until development of the
commodities market in the mid
1800’s trading was chaotic-corn,
wheat, and other crops would
pour into the big marketing cities
at harvest time. This created a
glut, and in turn, low prices for
farmers.
At other times of the year, the
situation was reversed. Stocks of
commodities were depleted, and
demand drove prices sky high.
With the changing patterns of
commodity movements, the main
business of the exchanges today
is the trading of commodity
futures-which are contracts for
the sale and purchase of yet-to-be
marketed products. Selling crops
this way provides wide
dissemination of information on
price expectations and thereby
facilitates a more even flow of
products to market. Today’s
futures prices reflect conditions
which eventually influence the
retail prices of eggs, bread, beef,
pork, and other products several
months hence
Unlike many other commodity
futures, livestock trading is of
relatively recent vintage. It was
not until November 1964 that
trading in live cattle futures
opened on the Chicago Mer
cantile Exchange. Trading in live
hogs began 15 months later
Since then, livestock futures
trading has literally grown by
leaps and bounds. Between 1965
and 1972, the volume of cattle
futures increased from 2.7 billion
pounds to 38 6 billion pounds.
Trading in hog futures went from
71 million pounds in 1965 to
almost 11 billion in 1972
In terms of dollar volume,
livestock futures trading is now
more than a $l6 billion annual
business
Why would a cattle or hog
feeder use the futures market? A
major reason is to attempt to
reduce risk from the sharp price
fluctuations common with
livestock.
For example, to use the
standard contract size of 40,000
pounds, a cattle feeder may put
40 head of cattle in a feedlot. He
plans to feed them to 1,000 pounds
each and then sell them. Hedging
this, he would be able to fix the
price for the cattle when they are
placed in the feedlot, 4 months
before the finished cattle are
actually sold
He would do this by selling a
futures contract calling for
delivery 4 months hence. In this
way, the price risk may be
partially shifted to a speculative
buyer of futures.
Chances are that this contract
will never be fulfilled. Instead, it
will be terminated by an off
setting transaction in which the
seller-the cattle feeder-will buy
back an equal amount of cattle
futures on the exchange before
the original contract comes due.
By maintaining opposite
positions in cash and futures
during the feeding period, the
hedger hopes to offset what
happens in the cash market by
what happens in futures. A loss in
cash will mean a gain in futures,
and vice versa.
Normally, traders have tended
to talk about hedging as if the
cattle feeder always sold a full
animal for every animal he had
on feed. In actuality, however,
the hedge is usually “in
complete”-that is, only part of
an animal is sold for each animal
on feed. Another way of saying
this is that the feeder trades in
smaller quantities on the futures
market than he does on the cash
market.
According to the ERS study,
the cattle feeder can best shift his
risk by selling about three
quarters of a steer for every steer
in the feedlot Over the years, the
study said, this “minimum risk
hedging level” has resulted in the
greatest stability of return to the
feeder.
The study also indicated-not
surprisingly-that the futures
market can be an effective way
for livestock feeders to reduce
risk Yet in spite of the rapidly
increasing volume of livestock
futures trading, it represents
only a small fraction of cattle on
feed in the U S In 1969, less man
5 percent of the II million head of
cattle on feed at the time were
covered by futures contracts.
Why don’t more cattlemen use
the futures market? According to
an ERS economist who
specializes in futures, one reason
is lack of familiarity-futures
trading is little known and even
less understood.
Another factor is past ex
perience. In its brief history, the
livestock futures market has not
always treated the “short”
hedger (the one who is selling,
who is literally short in the
futures market) favorably. This
is partly because rising livestock
prices have characterized the
market in recent years. When
prices are going up, it is logically
to the producer’s disadvantage to
fix a price for his cattle in ad
vance. When prices are
declining, he gets more by
“selling forward” in the futures
market.
The ERS study found that live
cattle and hog futures can “give
reason for concern about price
bias” against the short hedger.
Historically, it said, prices have
tended to rise over the life of the
contract, resulting in losses to
short hedgers. Over the period
analyzed in the study - from
March 1965 to March 1971 - in
creases in futures prices
averaged about 30 cents per
pound per month for both cattle
and hogs.
If this tendency were to persist,
price biases of this magnitude
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would present a serious carrier to
hedging. But the study concludes
that this is not likely to be the
case.
Some economists now foresee a
general lowering of livestock
prices.
They reason that sooner or
later the strong demand for beef,
coupled with record high prices,
will cause cattlemen to
overexpand. Slaughter supplies
will become greater than the
market can bear, prices will
drop, and cattlemen will no
longer hold extra heifers for herd
expansion. This in turn will put
even more cattle on the market,
continuing the cycle of lower
prices
It’s now anticipated that by
early 1974, cattle prices will be
down from current levels.
Though many things could
happen to upset this forecast,
there is general agreement that
the short hedger may soon find
the market in a position to treat
him better.
Meanwhile, futures trading in
livestock and other commodities
has not escaped criticism.
Among other things, there have
been charges that operation of
the commodity exchanges is open
to various abuses, including price
manipulation and other collusive
and deceptive practices. In
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