This year’s drop in grain prices, together with many producers’ inability in the West to deliver contracted grain, has left farmers scrambling to maximize revenues and even to generate some cash flow from last year’s production.
Many seem to be jumping into new marketing strategies. But first, they should ask themselves, their grain buyers, their marketing advisers, and their commodity brokers (if they have one) the most important question of all: “Am I marketing or speculating?”
It’s not that there is anything wrong with speculating, providing you realize that what you are actually doing is speculative, and as long as you understand the risks associated with your actions.
However, it isn’t always easy to understand such things, especially in farming.
For instance, Neil Blue is a marketing specialist with Alberta Agriculture who has spent much of his career teaching farmers how to use marketing tools such as hedges and options to reduce pricing risk.
Blue points out these are the very same tools that speculators use to try to profit from the market.
Even so, Ed Usset, grain marketing specialist at the University of Minnesota, says there is a fundamental difference between marketers and speculators, and it can be simple to put it into perspective.
“Speculators use futures and options to take a risk to make a profit,” Usset says. “Marketers use futures and options to reduce and manage price risk.”
While Usset’s distinction seems clear in theory, it can still be a bit fuzzy in practice. For instance, most farmers using futures probably consider their actions as marketing. As well, more and more farmers are using strategies that are bordering on speculation.
Examples of strategies which may be more speculative than risk-reducing include Texas hedges (short selling), selling wheat call options, and playing the spreads. In fact, Regan Espeseth, investment and commodity futures adviser with RBC Dominion Securities, points out that holding unpriced grain in the bin could also be considered speculative.
“It is tricky to say where marketing ends and speculation begins,” Espeseth says. “No strategy is wrong if you know what you are doing and how to do it. In today’s markets, farmers will have to get more creative in marketing their production. They simply cannot wait until it (the harvested grain) is all in the bin. Learning to use marketing tools like futures and options is very important.”
Espeseth tells producers that marketing strategies must be looked at as a piece of their farm operation. “Don’t be afraid to spend some money to hedge grain,” Espeseth says. “There is no such thing as a zero-cost, zero-risk marketing strategy.”
Aside from holding unpriced grain in the bin, the most common speculative strategy that farmers regularly use is selling the grain and then replacing those stocks with futures or options contracts to capitalize on higher prices expected later in the year.
Espeseth says farmers doing this, or considering replacing actual production with paper, need to be asking themselves: “How much am I willing to risk to get market exposure back?”
Blue, Usset, and Espeseth agree that a critical step is learning how price risk management and marketing tools work and how you can use them on your farm to enhance your business’s success. Each of the experts also recommends that farmers take marketing courses that focus on hedging and options.
Our experts also believe that the most important thing to remember when marketing — regardless if you are hedging or speculating — is that your primary focus must be on your risk. Risk management must come first!
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While the basics of hedging, options, and reducing price risk can be taught in a classroom setting, the real learning happens when a farmer actually places a hedge or purchases an option position.
Keep in mind, therefore, that the best marketing courses usually incorporate a simulation that allows you to put into practice the information you learn in the course. Your provincial agricultural department or a brokerage office may be able to direct you to a futures and options course being held in your local area.
For anyone seeking to increase their knowledge and experience in futures and options but who is unable to attend a marketing course, you might want to consider Commodity Challenge.
Commodity Challenge is a unique futures and options trading simulation game developed at the University of Minnesota to teach commodity marketing skills to both students and farmers. The biggest difference between this simulation game and those offered through many marketing courses is that Commodity Challenge is open to everyone and there is no cost to participate. You do not need to enrol in a class or course. Anyone can join an ongoing simulation game anytime.
Second, Commodity Challenge follows the actual, real-time cash, futures, and options quotes as provided by GeoGrain, DTN, and the major U.S. commodity exchanges. The trades you make in the simulation on any day would exactly mirror your results if you had actually bought or sold futures or options that day.
Unlike most other simulation games, this one limits speculative trading. Participants assume the role of an actual grain producer and they are limited to trading two times the production on their simulation farms. This level reflects the trade volume needed to place and close a hedge position. It ensures participants focus on learning how options and hedges work in managing price risk, and that all economic benefits arising from using these tools come from managing risk rather than profits (or losses) from speculative trading.
The final advantage of this game is that a group of farmers, students, or like-minded individuals can easily create a private group within the game. This feature allows a small group to learn together how hedging and options work, and it enables group members to compare the results of their marketing strategy with actions that other members of the group took. Simply emailing Ed Usset, the game administrator, and providing him with a list of participants, your location, the intended start and ending date for your group, as well the crops you want included (corn, soybeans, HRW, SRW, HRS wheat), is all that is needed to set up your group.
The only drawback to Commodity Challenge is that your crop choices are currently restricted to wheat, corn, and soybeans, and it only follows the U.S. markets. However, the principles for hedges and options are the same for these crops as for other Canadian crops including barley and canola. Also, since there is a strong correlation between the barley and corn markets as well as the canola and soybean markets, paying more attention to the corn and soybean markets in the U.S. while playing Commodity Challenge may actually improve your knowledge of the real barley and canola markets.
Usset says Commodity Challenge was introduced more than a decade ago and last year more than 1,500 people in 12 states played the game. In the past he has had a number of Canadian farmers participate. He has even had an expression of interest in offering this game in Australia if an Australian market could be included as an option.
If interested in playing Commodity Challenge, go to www.commoditychallenge.com.