08—Lancaster Farming, Saturday, August 14,1982
Farming’s Futures
By David K Sauder
Commodity Broker
Trade Tech, Lancaster
Pitfalls of Farmer Hedging
Commodity hedging is not
something to be entered into
lightly, without extensive study
and preparation. Farmers who
make the decision to hedge without
considering the risks, along with
the benefits, have already made
their first mistake.
As a guide tor inexperienced
hedgers, here are some major
pittalls into which farmers have
fallen in the past:
Bypassing the basis
The first step in using futures
markets effectively is to study
your local basis the difference
between the futures market price
tor a selected month and your local
spot market price.
Without knowing your local basis
and how it typically behaves, you
have no way of knowing whether
the price otter by the futures
market is attractive.
Slipping into speculation
Countless stories tell of farmers
who "lost big money’’ in hedging
programs. All too often, it turns out
that t.he farmer who lost money
had gone beyond a sate hedge into
a risky speculation.
Hedging is a temporary sub
stitute lor a cash transaction
planned later tor the physical
commodity a gram farmer
selling the crop, a teedlot operator
buying teed or feeder cattle, or a
hog producer selling hogs.
If a particular transaction is not
clearly a hedge, then it should be
recognized as speculation.
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When you hedge, the odds are in
your tavor it you understand the
futures market, have a good fix on
your production costs, and lock in
prices that will provide satisfac
tory returns. The odds shitt
dramatically when you start
speculating.
Becoming a "know-it-all”
There’s an old axiom among the
floor traders at every futures
exchange: "The trader who is
certain where the market is going
has no business here, and won’t be
here long.’’
Overconfidence - whether
based on some advisory service’s
"guaranteed formula,’’ your own
extensive research, or even the
success of a well-planned hedging
program can encourage risk
taking and court disaster. ISo one
knows tor certain where the
markets are going, or when.
Floor traders make money and
then lose it. The speculator who
writes a book on how to make a
million dollars in commodities
may be broke before the book is
published.
Even one of the majoi gram
companies lost more than $BO
million in one 3-month period a lew
years ago (primarily in cash
market commitments) because it
misjudged the soybean market.
Futures prices at any given lime
reflect all that is known and all
that is expected on the value of
commodities being traded. This is
why a bearish crop report is often
followed by a price increase -
because the traders had expected
an even more bearish report than
they got.
In other words, you should
always assume that any m
torinatton that comes your way
has already been analyzed and
acted upon by other traders who
devote 100 percent ot their time to
futures markets.
But while "professional” traders
may have taster access to a more
complete picture ot the overall
supply and demand situation, you
probably know the production
situation in your own area more
intimately than anyone outside
that area. So your comparative
advantage is in hedging your own
risks, judged in light ot your own
costs.
More pitfalls next wedk.
Send your questions about
futures ' trading to Farming’s
Futures, Lancaster Farming
Newspaper, Box 366, Lititz, PA
17543.
Palz
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