Risk management
by Lorne McClinton

You don't have to live near a commodity exchange to trade futures but, traditionally, it has been an advantage. Markets can turn on a dime and it was helpful to be where the action was to keep pace.Today, there is so much information on global markets and weather available on the Internet that producers can stay on top of market trends and use the commodity market to manage risk from home.

Unfortunately, only a small percentage of producers use the tools at their disposal. Even if you never use a commodity exchange yourself, understanding the markets will help you use the pricing tools offered by various grain buyers and brokers.

The sharp decline in canola prices during the last half of 2005 is an example of the risks producers experience. Anyone who didn't have a price locked in through a production contract with a grain company or who put options on the futures markets watched helplessly as prices tumbled from near record highs to near record lows. Those that did hedge their canola protected themselves against the drop in values on at least part of their production.

Jason Watson, a farmer near Yellow Grass, Sask., has been using his commodity trading account to hedge the value of his canola since 1996. “Canola's an easy crop to trade,” Watson says. “Over the long term I think I've done all right when I've used the markets to hedge the price I get for my crops. I haven't done as well when I've gone in to speculate.”

A futures option is an almost risk-free way for producers to lock in a minimum price. “If you went out and bought a put for your canola, you are just locking in the downside price for your crop,” Watson says. If you locked in a $300 a tonne price, for example, it might have cost you $5 a tonne. The worst you can do is lose your $5 but if you do, that means you sold your canola for more than $300.

Basis, the difference between market price and the price you receive for your product, is also something to watch carefully. “If there's $20 basis level, I'll lock that in and then look for an attractive future price,” Watson explains. “If we haven't anything priced in at harvest,and the basis level is low, we'll start selling it and buy it back on paper, if we think it's going to go up.You get rid of storage risks, you get a pile of cash coming in and you free up bins.”

Watson learned how to trade commodities in a marketing class in university. His father also used the market to hedge his feeder cattle. Unfortunately, very few producers are confident they have the necessary skills to manage risk by using the markets. A risk-free way to hone your trading skills is by setting up a trading account on FACTSim, the University of Florida's online commodity trading simulator.

FACTSim, developed by University of Florida professor John Vansickle, applies the 4-H approach, “learn to do by doing,” to the commodity market. “I train a lot of farmers on the use of futures and options,”Vansickle says. “It's one thing to show them the theory on how to use these tools but it's another to get them to pull the trigger when they're trading real commodities. FACTSim is the practice before the real game. It gives them hands-on experience to how the markets operate without risking real dollars.”

Since FACTSim trades use real time data from the North American commodity exchanges,Vansickle doesn't like to call it a game. If you made money on a FACTSim trade, you would have also made money if you had made the same trade through a brokerage account. While it is possible to trade any commodity handled on the major exchanges,Vansickle suggests farmers start with ones that relate to their operations. If you grow wheat, corn or soybeans, start with those and develop information sources you can watch as these markets evolve.

“I suggest adding an element of competition to your trades to keep it interesting,”Vansickle says. For example, he recommends family members challenge each other to see who can do a better job to market the crop.

Producers can sign up for a trading account on FACTSim at www.factsim.org. For $30 US, users get a six-month subscription and a $50,000 trading account ($50 US for an annual subscription). If you run out of money, you can arrange for a loan from the FACTSim bank. A loan fee and interest will be charged to your trading account.

Simulated trading is a low-cost way to get actual trading experience. This, combined with using the market information available on the Internet, can go a long way to help manage risk in commodities that are actively traded.

Information is a click away

The major commodity market websites are logical places for producers to start monitoring market trends. Grain producers, for example, can easily find and lock in canola prices by going to the Winnipeg Commodity Exchange, www.wce.ca, soybean and corn prices at the Chicago Board of Trade (CBOT), www.cbot.com and wheat prices at the Kansas City Board of Trade (KCBT), www.kcbt.com. Livestock producers can track price trends and hedge hog and cattle prices at the Chicago Mercantile Exchange (CME) at www.cme.com. On Canadian Wheat Board grains, information on the various Producer Pricing Options can be found at www.cwb.ca. The Ontario Wheat Producers' Marketing Board website is www.ontariowheatboard.com.

Do you want to know how the Ukrainian winter wheat crop is faring?

Check out the USDA international commodity intelligence reports at www.pecad.fas.usda.gov.

Is the rain in Spain falling mainly on the plain?

Check out the weekly European precipitation maps at: www.cpc.ncep.noaa.gov/products/ analysis_monitoring/regional_monitoring/europe.html.

Does it make sense to plant oats in 2006?

Check out the current stock-to-use ratios available in Agriculture and Agri-Food Canada's biweekly bulletins for Canadian Grains, Oilseeds and Special crops at www.agr.gc.ca/mad-dam/e/bulletine/v19e/v19n01_e.htm.

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