The Cure for High Commodity Prices: Hedging

march.corn

March Corn (click for larger picture)

Didn’t the US Government pay farmers to NOT grow corn? That was quite a gamble, especially since they don’t allow for sugar ethanol. Now the food companies and the ethanol producers are jamming up the prices on American consumers.

Had they hedged, they could have passed the savings on to consumers, just like Southwest Airlines did from their effective fuel hedges during peak oil. By not hedging, food companies are in effect gambling that prices for their raw materials will stay within a range. But when scarcity hits the tape, they can blame speculators (whatever that means anymore) and push the costs off on consumers in order to protect their profits. They can do this by increasing prices, or by decreasing the size of the containers they sell the food in and keep the prices the same. You get less food for the same price, hence an increase in food prices.

What the food companies do is gamble that their competitors won’t hedge either, an extremely reckless way to run a business. If the prices go up, none will look so bad as all the firms will have to raise prices. In the meantime, the large space under the curve when things are “normal,” food companies can jack their earnings higher by saving the insurance money they would have used to hedge.

When your compensation is in stock, you’ll whore out your balance sheet and income statement to get the stock price as high as possible. I believe that they are gambling their company for the sake of their Executive Compensation plan. Myopia, USA.

An article in Agrimoney.com stated that “corn and cotton are to win this spring’s battle for acres on US farms, enjoying hefty increases in sowings, US officials said in a report forecasting crop prices would stay “historically high” for at least a decade.”

march.cotton

March Cotton (click for larger picture)

Hmm, more forecasts…I love it. High prices for the next decade. I guess that means for all the new plantings, there will still be insufficient crop surplus to drop the prices of at least corn and cotton. The unnamed US officials must have a line on the US dollar then…that must be the cause for high commodity prices going forward the next ten years. These people are f’n talented man…people of vision. Sir Richard Branson should be looking to recruit his successor from this lot for their vision.

Farmers rush to plant crops of the highest price commodities so that they can potentially earn more $$$ from their farmland. But it’s not a science per se, they have to account for the fact that every crop has its own unique costs.

If the farmers over-correct and create a bumper-crop…a giant surplus…the prices of the commodity drop very fast. Therefore, it is said, that high prices are the cure for high prices. Farmers can use futures or options on futures to lock in the higher sell prices long before the crop is ready for harvest. Food companies can use the same tools to lock in lower purchasing costs.

American CEOs who don’t hedge are the real gamblers in the commodity markets. Not having an effective hedge on is still a position in the market.

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