A couple decades ago I had the privilege to speak at the USDA Forum in Washington, D.C., on risk management. Little did I realize my version of risk management did not jive with RMA, which was beginning to implement crop insurance. A time thereafter I also testified in Congress on the same subject as it pertained to which crops would be covered and indemnities. Since then, RMA has increased its presence and risk management, as I define it, seemed to never be further apart. Crop insurance has seemingly overshadowed hedging.
I define hedging as the ability to sell bushels and to lock in a futures price while still maintaining physical ownership and price flexibility. I have heard every reason (excuse) in the book for not using futures and options. Here are my responses on a few.
It costs too much.
A: It is all relative. The variable input cost to plant corn is about $350 per acre. Investing in hedging is about $25 per acre per 100 bu. Hedging is an investment as it is returned when exited, so the only real cost is the cost of money. The current margin of 5,000 bu. of corn is $1,250. Risk management should be a line item in your budget.
LISTEN to Michelle Rook’s Aug. 2 podcast with Jerry Gulke.
No one knows where prices are headed.
A: This requires an education of the importance of global supply and demand.
• Bull markets will go up until price rations demand and what is grown will be enough.
• Bear market go down to discover a price that will find new demand and clear out excess supplies.
I never make any money.
A: The point is to lock in a profit, not a loss. If prices rise, it’s an opportunity to have made more than is lost. Your tax form schedule F will likely show a profit when there are hedging losses.
I can’t sell something I don’t have.
A: The market doesn’t care what you personally grow. The market is much bigger than one person. Futures and options allow the flexibility to manage the total market risk, not just your back yard.
It requires too much time.
A: We have time to become agronomically proficient to grow the best crop we can (supply), but not enough time to understand demand. When I started farming, I forced myself spend 1% to 2% of my gross income on marketing education. That is $10 per acre minimum on $1,000 per acre gross. You are going to get an education one way or another; you might as well be ahead of the curve.
The market is “rigged” against me.
A: This is due to lack of understanding. Educate yourself or find someone who is educated in risk management, preferably someone who has skin in the game. When I buy stock in a company on the advice of my stockbroker, I ask him how much he has purchased for his mother.
What I Do
I use price charts as well as the fundamentals of supply and demand in my decisions. The chart below is of new crop December corn futures (CZ). When the current CZ expires, I chart the next year’s CZ accordingly. It reflects new corn futures over the past 17 years since ethanol became a price driver.
A cursory overview shows price evolution higher as we invited competition, then oversupply and the price of corn sank to levels of the rationale “no one knows where prices are headed” excuse above. The price road map reflects opportunity and adversity that affects our bottom line profits perhaps more than agronomy. The opportunities are obvious even if one elects to use cash forward contracts (losing beneficial interest) on 40% and manages the risk via hedging on the rest maintaining flexibility.
Price Concerns
Note that CZ24 has broken through the $4.50 level as of press time, creating concern for the future. Corn has entered a price void with seemingly nothing but air under it, especially as the media is expecting huge inventories still unsold and in farmer hands to come to market. Remember, the world won’t care if you personally grow a crop or not — using risk management flexibility has its benefits.
