It’s fairly common in the commodity trading world to initially only think in terms of technical things like moving averages, bollinger bands and all sorts of exotic combinations of these in the quest to generate trading signals. So much so that it’s possible to not even consider the many uses of the market, of which speculators only form a part.
Michael wrote a piece of Barron’s back in June 2011 on the huge demand China has for pigs and how this affects in turn corn prices. Hungry Hogs Lift Wheat Prices.
Smithfield Foods, Inc. produces and markets a variety of fresh meat and packaged meats products both domestically and internationally. They pretty much know everything pork and hog related. In the USA you may have heard of their pork business Smithfield Packing Company, Inc. (Smithfield Packing), Farmland Foods, Inc. (Farmland Foods) and John Morrell Food Group (John Morrell). They also have hog production operations in the USA as well as food processing, distribution and meat processing operations throughout Europe and Mexico.
Clearly they know their pigs, but did you know, that hog feed is an 80/20 blend of corn and soybean meal, and it takes four pounds of the stuff to produce a pound of pork?
As you can perhaps gather from this; a company so heavily focused on the hogs has to be focused on the grain markets as well. Looking at both corn and soybeans at all time highs and the current drought in the US negatively affecting the supply of these grains their costs of doing business are clearly rising.
This is where Smithfield Foods Inc. provide an example of where hedging fits in commodity market, as well as company strategy.
You see, Smithfield missed their forecasts with their quarterly earnings and have reported that their domestic hog production will be “negatively impacted” by the jump in feed prices. But they have been employing a hedging strategy and they believe their “favourable grain hedges” will limit the damage of the high grain prices the market is experiencing.
Larry Pope the Chief Executive said “our successful risk management strategy should meaningfully protect margins and produce results that are significantly better than the industry as a whole”.
With such serious increases in the feed costs that their business is so dependent on it would not be unforeseeable for them to have had some crushing losses. However, as a result of intelligent hedging in the commodity futures markets over the whole year, at worst they expect a “marginal” loss and even perhaps a small profit.
Commodity speculators who all too often get a bad rap are often on the other side of these trades allowing the transference of risk for such companies as Smithfield Foods Inc. Smithfield look to transfer the price risk that high grain prices will have on the business by locking in prices in the futures market at a level acceptable to their business and the speculator looks to make a profit for accepting that risk.