Why Farmers Should Have a Hedging Strategy
From hard work and early hours to inconsistent profits, farming is a challenging industry. Uncertainty riddles the dairy markets every season through increased feeding costs, harsh weather and low yields. One way dairy farmers can reduce some of the uncertainty and risk is to engage in hedging strategies.
How Hedging Helps Farmers
Hedging can protect dairy farmers from unexpected, collapsing market prices. While it’s true that without an actively managed hedging strategy there is less of a chance of reaping in the benefits of extreme high prices, its primary goal is to ensure consistent profits and that the farm remains open for business the following year. Hedging seems like a difficult concept to implement. However, working with a professional who can actively manage the strategy will provide many benefits to the farm without interrupting much of the day-to-day operations. To simplify the process, hedging starts by opening a position – either through purchasing or selling contracts. The farmer must then offset the original position at a later date. For example, if a farmer buys a futures contract in their first position, then they must offset it later by selling in the second position. The second transaction will usually occur when the cash market transaction takes place or when risk is covered since hedging price protection may longer be needed.
Protect Against Falling Prices
Hedging can make profits more consistent through establishing a price floor or ceiling, depending on the selected strategy. When the markets are expecting a surplus of milk, a dairy farmer will want to brace for lower profits due to the expected lower prices. One way to do so is to lock in profitable prices for the future. If a farmer can profit on milk by selling milk at $10.00, then they will want to lock in a future price above that to offset the expected lower profits and to reduce risk. This gives farmers the opportunity to earn a profit even when they are faced with falling prices. Similar to how a surplus can lower prices, lower yields can be destructive to profits as well. Regardless of which direction markets move, a hedging strategy can offset costs. An extremely dry, hot season can thin herds through heat exhaustion or less food from reduced yields. Milk markets are also susceptible to perceived and actual changes in demand, which are out of the farmer’s control. With so many variables threatening profits, the need to implement a hedging strategy is important to the health of the farm.
Where the Opportunity Lies
Since milk is perishable, it is sold in a passive manner rather than in large sums like grains. While possible, it is more difficult to trade milk in the futures markets. One way to manage moving market prices is to enter the grain futures markets. This can help control the costs of keeping cattle alive and healthy, and it can make the financial statements more consistent.
Market prices in the farming industry hardly ever stand still, and are always correcting based on changes in supply and demand. Implementing a strong hedging strategy can offer downside protection or leave the door open to capitalizing on upward market swings. Whether a farm produces, consumes or a combination of the two, employing hedging strategies can provide a competitive edge and reduce risk in markets that are riddled with uncertainty.
About Howard Marella
Howard Marella was on the front lines of the trading floor at 21 years old eventually earning his registration as a floor member at the CBOT and CME. Through the extensive experience he received on the floor, Howard hand-picked his own team and began his own business. In 2006, he launched Marella Capital Corporation which stood strong the the economy’s toughest tests, and it eventually flourished into what is now known as a leading, forward-thinking futures investment company, Icon Alternatives.
About Icon Alternatives
Icon Alternatives is a Chicago-based, forward-thinking alternative investment firm that specializes in futures contracts. Their experience has deep roots reaching back to the golden age of floor trading in the ‘80s to acting as committee heads for the CME in the last decade of Index Futures Group. Icon Alternatives remains ahead of the curve to provide investors true portfolio diversification as investment theory continues to change.
Why Farmers Should Have a Hedging Strategy