Whether you’re a grain, oilseed, specialty crop or livestock producer, the Canadian dollar has caused you a lot of pain in the last year. And there may be much more to come. Remaining exposed to the rising Canadian dollar is likely to have a direct financial impact on the bottom line of Canadian producers in 2010, especially with our dollar in a firm uptrend.
Analysts now suggest the loonie may push even closer toward parity with the U.S. dollar over the next few months. Time will tell, but the devaluation of the U.S. dollar has been a key support for commodity-based currencies such as our loonie as well as the Aussie and Kiwi dollars.
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The rising Canadian dollar is definitely a double-edged sword. Appreciation of our currency is great for vacationers or for buying that second home south of the border. But it’s a tough pill to swallow for the Canadian grain and livestock producer. Currency fluctuations can easily make all the difference profit and loss.
Fixing currency exposure can be done through a bank, through your commodity broker, or sometimes even through your buyer. By fixing the dollar, you effectively eliminate the risk of the Canadian dollar moving even higher while you own unpriced grain stocks or livestock.
For instance, when Canadian cattle are exported into the U.S., every one-cent change in our exchange rate has impacted our slaughter cattle bids nearly one cent per pound in recent history. A one-cent change can affect canola and flax bids by as much as $10 per tonne too, and edible pea and specialty crop bids are also very sensitive to swings in our dollar, as are eastern corn and soybeans.
By fixing the dollar, you effectively eliminate the risk that further currency appreciation will erode your business margin. If dealing with a commodity broker, this can be achieved by either placing a long hedge (buy the futures) and/or purchase a Canadian dollar call option. Any of these strategies protects producers from unexpected surges in our dollar wiping out production profits.
Here’s an example using options:
It’s February. You decide to lock the Canadian dollar to prevent further currency erosion on production profits. You phone your commodity broker and say, “Buy one June C$.90 call option.” This call option gives the purchaser the right to buy C$100,000 at US$.90.
Lets say the cost of this right is $1,000. This cost is also known as the “premium.” From a risk management point of view, the purchaser of the “call” is only exposed to the cost of the premium. In other words, should the loonie collapse to 85 cents at contract expiry, the producer would lose the $1,000 premium, but that’s all. The call option would expire worthless. But then the value of the production, whether grain or livestock, would like have gone up because of the lower Canadian dollar, so you’d likely still be in the black.
That’s if the loonie sinks. But let’s say the loonie surges to US$.98…
Livestock and grain bids would feel downward pressure purely from strong gains in the loonie. But the rising value of your “call option” would come to the rescue. In fact, your call option would appreciate substantially in value from $1,000 to $8,000 plus. (June C$.98 – $.90 right to buy = $.08 gain.) The call option is now $8,000 in the money.
This gain in the call option would help offset losses in the cash cattle or grain markets.
Buying the futures outright is another strategy for protecting yourself against bid erosion due to a rising Canadian dollar. But there are both pros and cons of this strategy. When buying or placing a long hedge for a Canadian dollar contract, the producer must margin the account.
For instance, a commodity broker may require a margin of $2,500 for every $100,000 Canadian dollar futures contract. These are funds the producer must place into a trading account up front. And there is a risk of margin calls. Should the Canadian dollar drop, the producer holding a “long hedge” may be exposed to a margin call. Additional funds would be required to maintain the long hedge position. But if the Canadian dollar falls, you are gaining on the cash side of the equation. Grain in the bin or cattle on feed may be starting to rebound due to a drop in our currency.
The bottom line is, purchasing a call option, buying the futures or locking the dollar through a financial institution is effectively a “currency hedge.” Should our dollar continue to rally, gains made in a long hedge or call option help offset losses in local bids prior to being marketed. A key benefit of a long hedge is the effectiveness of protection. For every penny our dollar rises, the long hedger receives direct price protection.
When profitability appears but there is a risk that a rise in the Canadian dollar may wipe it out, it’s time to consider fixing the dollar to reduce currency exposure. It’s during these market moments that opportunities arise to improve your bottom line. Keeping an eye on the Canadian dollar is just another way of reducing risk while locking profits through the entire production period.
Errol Anderson is located in Calgary and author of ‘ProMarket Wire’, a daily agricultural risk management report. He can be reached at (403) 275-5555. Email:[email protected].
