Scheve: The Difference Between Speculating Vs Managing Risk
Oct 22, 2018
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Market Commentary for 10/15/18
Exports this week were below what the trade was expecting, prompting a pullback in futures prices. Weather looks good for harvesting over the next week, which might keep the market under pressure.
I travelled from Minneapolis, MN to South of Lincoln, NE at the end of the week and the harvest is certainly still behind normal pace in Iowa. North of Ames was only around 25% complete while west of Des Moines was farther along but not quite half way yet.
Speculating or Managing Risk
Many farmers tell me they do well at picking prices. Maybe some do, but many do not. If farmers were good at predicting prices, most would have sold their 2017 crop for over $4.10 and would have their 2018 crop already all sold for $4.20. Unfortunately, most farmers didn't get $4.00 for their 2017 corn and few have much 2018 sold. Sadly, many farmers are fooled into thinking they are good at picking prices, when really they probably have been lucky.
Some farmers have the misconception that I try to predict prices and sell at the high. Unfortunately, I don't know when the market will be at its highest. And here's the thing.....no one else knows either.
Instead I try to "manage risk" in the market. What does this mean?
Know Your Breakeven Points and Be Prepared to Sell
Since I don't know where the market will go, I need to be prepared to sell all the time. That way I can take advantage of opportunities when they become available. The key is knowing your breakeven points and selling when the market hits adequate profit levels, because that may end up being the top of the market. Every time I sell, I actually hope it's the worst sale of the year.
Consider All Scenarios
I set up trades based upon what is LIKELY to happen, not what I HOPE will happen. While I always hope the market goes higher, I know for sure it won't stay at the top. The prices from 6 years ago won't be available in most years. For instance, the last time futures were $4.50 was 4 years ago. It’s been 5 years since corn hit $5. Therefore, since $5 corn has not happened in the last 5 years, I need to be realistic that it may not happen again for a while.
Nevertheless, I'm still a farmer that needs to make a profit and I will always have more grain to sell. Therefore, I optimize my grain marketing strategy to take advantage of the market if it goes up, but also if it goes down. I even make trades where I profit if the market moves sideways. By taking into consideration multiple scenarios, I reduce my potential risk.
Make A Plan
A plan can be as simple as writing a note on your shop door that tells you to sell some corn at desired levels. When that prices comes, listen to yourself from the previous months and remember you always have more corn to sell. Maybe not today, but for sure in 365 days you will.
If you're not sure what prices to write down on the door, start with pulling the following numbers:
- Yields - Pull the average yields for the last 3 years and the average yield from the last 10 years and average those 2 numbers together.
- Expenses - Pull the costs for fertilizer, equipment, seed, gas, etc for the last three years and average them out. Other than fertilizer these costs don't adjust much year over year. While fertilizer prices changes seem huge they don't change overall expenses on a per bushel cost all that much.
- These numbers when put together provide an easy and quick breakeven point from where to start marketing.
Plan For a Normal Year
I always plan for a normal year. Some years will be above average, and some will be below, but if I plan for average I will be right most of the time and certainly in the long run. When there is a good year, I bank that profit for the years that are more challenging. This allows me to ride out volatility swings in production, which has a big effect on breakeven points.
Keep Making Adjustments
This plan isn't a "set it and forget it" thing. You'll need to make adjustments as new information is provided. For instance, accepting $4.20 corn this summer was tough when weather appeared grim, but those that did are glad they did today, even if it was just on 10%. Knowing this, some farmers may consider selling even just 10% of the 2019 crop for $4.20 if we see it again, in case prices don't rally next summer.
Bottom line - farmers need to stop speculating on prices and trying to hit the top all the time. It's impossible to do every year. Sure, sometimes luck will be on your side, after all a broken clock is right twice a day. But, farmers can't afford to be wrong for too many years in a row. Instead, farmers need to "manage risk in the market" to stay profitable year after year.
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Superior Feed Ingredients, LLC
9358 Oak Ave
Waconia, MN 55387
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