Commodity trading

Some market participants have been caught short because they thought that they could read the market and left themselves open to price volatility. It is easy to make money on a rising market (bull phase), but when it ends you could suffer great losses. Farmers and experts alike, and unfortunately some pension funds, have lost money by speculating on the JSE.

Any farmer can have agricultural derivative prices delivered to their cell phone. Some use these as indicators and sign fixed-price contracts based on that exchange price. However, if the price changes those farmers will still have to accept the contract price, even though it is worse than the current exchange price.

Tips for Farmers:

• Keep in touch with the supply and demand conditions relating to your commodity. Try to obtain price forecasts, from 2 to 3 different sources.
• Regularly contact their grain brokers to get their opinion of the market – whether prices are going to rise in the future or decline, and their reasons for this.
• Understand domestic and world markets. Understand the limitations of price forecasting – accurate forecasting is impossible.
• Have a well thought-out, written marketing plan. It is recommended that you follow and chart futures prices daily. Analysis of why prices were strong or weak on a particular day is one of the most efficient methods of gaining knowledge of the grain markets.
• Where your marketing plan includes hedging; futures or options, be sure to include the costs in your calculations.
• Your marketing plan should be updated regularly and objectively. Use this information when deciding to sell or store your crop to take advantage of future price increase.
• Realise that high prices often stimulate production which can result in prices declining, hence the importance of locking in prices when prices are high.
• Do not store for too long, as storage fees are high and you will lose interest on the money you could have made if you sold. Farmers can always obtain the upside of rising prices with the use of financial instruments on the JSE. Consider all the costs involved and include shrinkage.
• Understand the futures markets – since futures are traded up to 12 months in advance, they extend the marketing season from a few weeks to 12 months – allowing you to take advantage of frequent temporary price increases.
• If prices increase at any stage – because of weakening exchange rates, weather and crop factors, international supply and demand factors and intentions to plant later in the year – then you have an opportunity to take part in those price increases. This strategy prevents “if only” scenarios.
• Prior to planting any crop, a farmer must see what price the futures contract for that commodity is trading at the time of planting i.e. July contract. If it is profitable to plant based on that price using an average three-year yield for that commodity, he can go ahead and plant. He must however hedge (lock in) that price by either forward contracting / or buying puts or futures. This means that he will not be exposed to possible price declines before he harvests the crop.
• Understand the options markets: Options offer new opportunities. Buy insurance against adverse price movements without you losing the benefits associated with favourable price movements. You do not have to put up margin money, as in the futures market and do not have to worry about having sufficient cash to meet margin calls. Also, there is no production risk associated with your marketing decision. Should your production be less than expected, you are not committed to delivery grain or offsetting your position. The ultimate value of these options depends on the cost of the insurance premium, (which changes daily), and the risk of adverse price movements.

Source: The publication ‘Finance for Farmers’ by Standard Bank.