Last week I started a series of articles outlining some of the hedging mistakes I’ve seen over the years. By definition, a hedge is a market position in one market offset by an opposite position in a different market. Often what begins as a market risk reduction program becomes a very high stakes speculative position.
In 1988, I had four farmer clients with a hedge line of credit. Yearly future price ranges were low. The farmers, their banks, and I all agreed that the bank would fund margin requirements up to $4 a bushel for beans and $1.50 for corn.
The agreement was that the four different banks would transfer funds by wire transfer from the customers’ cover line of credit directly to the customers’ cover account and the brokerage firm would automatically transfer excess funds from the bank when available.
The 1988 drought really started in mid-July 1987. Autie called me on April 24, 1988 to tell me he had finished planting corn and beans. Mid-May temperatures were frequently in the mid to high 90s. The first week of June we saw over 100 degrees become routine. Unlike the 2012 drought, the humidity was very low and sucked moisture from the ground and all living things.
The price of maize had been below the cost of production (about $2.25) since the 1983 drought.
On June 17, December corn was trading above $3.25. The farmers locked in a profit of $1 a bushel, an exceptional profit at the time.
Since there are no delivery requirements on the futures contracts, a high percentage of a normal crop yield was covered by the four farmers – almost half a million bushels. If they didn’t grow the bushels in 1988, they would in 1989. The margin money was transferred as it should have been every day. By late June, the cornfields looked like pineapples and had gone dormant.
The 4e July provided a 3 day weekend in 1988. This was July, the month when the corn harvest in the corn belt is made or lost. It was make or break corn harvest time and there was no rain in sight. Every farmer in America would have taken 45 bushels of corn if it could be guaranteed. At that time, CBOT began trading at 9:30 a.m. Chicago time.
The farmers and I learned on the morning of July 5 that the four banks had not made the margin calls issued the previous business day, July 1. Since corn futures were going to open sharply higher and banks hadn’t moved the money as agreed on Friday, brokerage firms were going to liquidate all short corn positions at the opening because the margin calls had not been and were not going to be satisfied.
When a futures account is opened, this is one of the things covered in the fine print. This is a necessary step to preserve the financial integrity of the futures markets.
The expectation of an event will move the market more than the confirmation of the event. And so it was in 1988. The multi-year high was reached on July 5 at $3.70, although the poor harvest was not confirmed until August 10. All of these hedging positions were redeemed (cleared, liquidated) on the day that would not be exceeded for eight years. None of the hedging lines of credit had used even 30% of the approved credit limit.
Why have the banks disconnected? “We lend money to cover maize and beans. With this drought, there will be no corn or beans. Therefore, these hedging positions are speculative and we do not fund futures market speculation. »
It was amazing that the four banks, supposedly independent of each other, had come to the same conclusion on the same day. When people change their marketing plan while under significant emotional stress, it is a reliable indicator and a characteristic of markets peaking or troughing.
December corn had fallen to $2.48 by the end of this fall, $1.22 below the July 5 high. This meant the farmers had lost 45 cents in the hedge and would have sold corn for less than $2.20 net with the base. A total disaster with the short crop of 88 bushels per acre, 70% of normal yields.
Fortunately, these farmers compensated their hedge price because, while their hedges were liquidating at the highest price traded between 1983 and 1996, their grain dealers were selling every one of those bushels on HTA contracts. I have never loved cereal vendors so much as on that day, July 5, 1988.
Learn more about this series:
The Power of Hedging Positions
Wright is an Ohio-based grain marketing consultant. Contact him at (937) 605-1061 or [email protected]. For more information, visit www.wrightonthemarket.com.
No one associated with Wright on the Market is a cash grain broker or a futures broker. All information presented is researched and believed to be true and correct, but nothing is 100% in this business.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.