Futures Hedging Advisers

[rayfcom]

We were discussing in previous thread the benefits of hedging the prices of future production, and I opined that there probably were some advisory services or brokers that have a decent track record of consistent profitability in using futures contracts to protect future profits and cash flows. I was asked what would be a good strategy to follow in this endeavour, and I said that I did not have the Holy Grail but that there probably were some very talented firms that could supply that kind of advice.

Subsequently I happened to look into Cargill's website, AND WHILE I HAVE NO IDEA HOW GOOD THEY ARE IN THIS WORK, I did find that they do have a branch of their company that performs these kinds of services. See the link below :

https://www.cargill.com/price-risk/risk-management-home

If anyone knows of any other firms that you know of that perform hedging advisory services, perhaps this would be a good place to list them, and if you wish, provide some color as to your opinion of their services. It could be very helpful to a whole lot of people, especially at critical turning points in the overall economy and in commodity prices.

[Hobbyfarmer]

Another link to bottom third marketing services

[rayfcom]

I am not advocating their specific service, but rather trying to compile a good resource that others have found helpful in protecting their profits and cash flows. 

Since you seem to be so knowledgeable about what you term "bottom third marketing services", can you offer some information about the the ones that you have found to be in the "top third" ? Additionally can you offer your perspectives on what qualifies an advisory service or brokerage firm to be a bottom third marketing service, so at least through your contributions the rest of us will have some guidance regarding what to avoid ?

Please feel free to fill this forum with your wisdom and lessons gleaned from your experience in the industry !

[JimMeade]

I don't use and don't know much about any hedging services.  My hunch is Cargill's main goal is to develop a pipeline of product for their uses and while they want to make money for you they are more worried about making money for them.

In other words, I would feel like giving Cargill some numbers to work with is about the same as pricing later - they essentially have the grain and can factor it in to the big picture and so they are less likely to pay a risk premium to get control of it.

It seems to me hedging is the producer locking in a price and the buyer being willing to pay a little over market to have assurance of getting the product.  It would seem to me that using Cargill to hedge would be like putting one's grain in the local elevator - the elevator knows how much it has and knows you are likely to sell through them so they don't have to bid up as much for it.  Just my guess.

10 or 15 years ago the University of Illinois had a project under AGMAS.  The Performance of Agricultural Market Advisory Services in Corn and Soybeans .

If I remember right, performance one year didn't necessarily carry over to the next year.  For example, a bullish advisory service would do well in a rising marketing but if prices fell the next year that service wouldn't fare as well.  That says to me that it may be hard to find a service that will perform in the top third of every market.  With my luck I'd always be on the back side of the power curve.

[WCMO]

Many years ago, there were a couple of studies referenced in a grain marketing course I took in college -- the studies compared various methods of farmer grain marketing -- strictly cash sales, compared to futures hedging, options, etc. -- over time, the "winner" was consistently cash sales.  Part of this was due to transaction costs, part was due to in-and-out (not strictly hedging), part was due to timing, etc.  Just one of those things that stays in mind when making marketing choices.

[JimMeade]

Here is a link to the various 10 year market advisory studies.  The last year was in 2004.  I asked Scott Irwin, who ran it, and he said he thought the results if repeated would be rather similar, so maybe the info will be of some use to you.

http://www.farmdoc.illinois.edu/pubs/agmas_search_all.asp

[rayfcom]

Cargill or any other hedging advisory service has little to gain save for a transaction commission by having you as an advisory clients. Your transactions would be performed through an exchange and the adviser would most likely not be the party with whom you transact with., Besides, if the adviser wanted to make a position in the futures market,m they would not have to wait for your order, as several hundred thousand corn contracts trade every trading day.

Your second point is quite valid about the accuracy of the advice. Which is why I suggested that you request a track record of past performance for any adviser you consider. If you can find someone with a consistently good track record, and you can, while that past performance does not guarantee future success it does tell you that the adviser has a good read on the market.

My feeling is that to disregard financial engineering in one's farming business today reduces the odds of profitability. As you correctly point out, the hedge locks in a price for your product, taking away some risk from your work. The reduction of risk, especially at critical junctures in the overall economy and in the price action of the commodity you will be bringing to market, is an undervalued aspect of the farming business. Just look at how many farmers thought they would be getting $4 a bushel back in April when they were planting their seeds. Now when its time to harvest and after the huge price drop of the past few months, they will be lucky to secure $3.50. A good adviser could have pointed out that corn above $4 was becoming more and more rare, so why not take advantage of one of the few times in the last couple of years when you could lock in that price for some of your coming product. It made good sense at the right time, which is the reason for incorporating a hedging strategy in your work. 

[rayfcom]

Remember that those studies are completely dependent upon the quality of the hedging adviser selected. Which is why I advocate examining the performance track record of the prospective advisers you are considering in a hedging strategy. The ones who beat the cash sales only alternative have a good chance of improving your profitability and cash flow.

Additionally, those studies you refer probably were not dynamic hedging programs. I don't think its necessary to employ continual hedging strategies, but to implement them at times when the risk to prices is greatest, Such as when the overall economy appears to be stumbling, or the price and momentum metrics of the market suggest that down is more likely than up in terms of future price direction. Once you add in these qualifiers that make your hedging strategy more selectively implemented, then I think you will find a different outcome than in those studies.

[rayfcom]

I could spend all day tearing apart this academic research because it is typically academic. It assumes a static price advisory rather than a daily re-evaluation of market forces, it lumps all advisers into an aggregate average, and it assumes that each adviser will make one sell recommendation per growing season rather than several. Its the way academicians approach the problem, but not how a proper dynamic hedging strategy is performed in reality.

The better analysis is having an adviser show what recommendations s/he made during a growing season, telling you what dates and what price they recommended putting the hedge on and taking it off. Then calculating the profit or loss from each hedging position, and overlapping that performance with the actual sales you made of your inventory. If their hedging transactions generated a profit relative to your performance, then it was beneficial to you to have employed their service. That's the only good way to evaluate a hedging strategy, at the granular level and not at 30,000 feet above ground as most academic studies do. 

[JimMeade]

Winning The Game is a marketing strategy put out by Ed Usset of the University of MInnesota.  It compares several different approaches to marketing.

It has two modules - one is pre-harvest marketing and one is post-harvest.

I've taken both over the years.

It's useful to get a general idea of various options, but would take much, much more than a 4 hour presentation with a free lunch to develop market skills.