Mecardo Analysis - A look back at the past, to see the ‘futures’
- By: "Farm Tender" News
- Cattle News
- Oct 16, 2018
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By Andrew Whitelaw | Source: CME.
The use of financial price risk management tools by farmers remains quite low, with very few producers utilizing the opportunity to minimize their price risk. In this update, we provide a simple analysis since 1980 to present, to determine the value in hedging at seeding.
The futures market provides an opportunity for both producers and consumers to protect from the risk of a fall or rise in the market. The use of derivatives in Australia remains relatively low, however they provide a valuable function. The aim of this article is to examine the long-term value of hedging using Chicago futures.
The analysis conducted for this report exclusively examines the futures component of pricing. It does not consider either fx or basis. These are important factors contributing to the overall price received and will be covered in a future report. Nonetheless, in a typical year the futures element of pricing is the most important factor.
To determine the effectiveness of hedging, I have examined the average price in March for the following December contract. The change in price when taking out cover in March versus holding out until harvest is shown in Figure 1. This chart displays the percentage advantage in hedging in March versus the harvest futures price. A positive result shows that the December contract closed lower than the average price during March.
Since 1980, the benefit from hedging in March versus holding until December has been on average 8%. When 2008 outlier year is removed, the average drops to a still respectable 5%.
During the past 37 seasons, there have only been 13 instances where the December contract has closed higher than the average March pricing level. It must be considered that this is a very simple measurement of hedging and does not take into account any active management.
To see the historical change in price for hedging from seeding onwards using Chicago futures, I have created a table on the following link:
Key points
* Since 1980, if you were to have locked in Chicago futures in March without any active management, your end result would have been 8% higher on average.
* In the past 37 years, December futures have only closed higher than march on 13 occasions.
What does this mean?
It is important to remember that this is a simplistic analysis to determine the value in hedging. Overall it shows that the December futures price in March is typically higher than its final closing price.
We would never advocate for a blanket strategy, as every year is different. As an example, if futures prices were extremely low at seeding, we may advise being unhedged to avoid locking in a loss.
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