Historical instability in the cash hog market, punctuated by prices in the teens in late 1998, and a precipitous drop in prices in the spring of 2009, when the H1N1 influenza outbreak struck, stand as important reminders of why pork producers are looking to the futures markets for financial security.
Cash price volatility of 20-30% has become commonplace, sending producers scurrying for a safety net.
Using hog and corn futures to price forward your hog production and input costs, and futures and options to provide an “insurance policy” against downward price spirals in the hog market and price spikes in the corn market, form key elements of a risk management program, according to Thomas Clark, Commodity Products, CME Group, Chicago.
“Risk management is probably one of the most important aspects of your business today,” he said in a talk at a World Pork Expo seminar last month.
Times Have Changed
Producers have always searched for sound investments (e.g. genetics, feed) to capture additional efficiencies. However, risk management was rarely a consideration, and might not have mattered much in earlier times when markets were more predictable, Clark suggests. During periods of historically low corn prices, hog producers could manage that input cost through cash market purchases or other traditional methods of procurement.
But times have changed, and producers must be more prepared for uncertainties. In short, “risk management is a structured approach to manage uncertainty,” he adds.
“The big question today is — what are you doing to manage your risk in the marketplace?” Clark asks. A common pitfall among some hedgers is deviating from their marketing plan and waiting for higher prices to appear on the futures market board, he says. “Often, those higher prices simply don’t materialize,” leaving the farmer a market speculator who simply let a reasonable profit margin slip away.
Instead of taking a chance, develop a marketing plan — a road map of what to do and when to do it — and follow it, he advises.
It is crucial to figure out where you are vulnerable — feed, transportation, energy or your credit line at the bank — as all are exposures that must be part of your marketing plan.
“Marketing plans are vital in that they add discipline to your operation. It makes you figure out your breakeven costs. Without it, you have no idea whether you made a profit or not,” Clark points out.
Seven Steps to Success
Clark outlines seven steps to help maximize the chance of success in the hog and corn markets:
- Know your cost of production.
- Determine your breakeven levels (overall costs).
- Utilize sound marketing information. The Internet can be a useful tool, but use caution to screen out bad information.
- Set target prices that return a reasonable profit.
- Evaluate marketing tools, including cash sales, forward contracts, futures and options and over-the-counter (OTC) markets. “Make sure that you use all of these tools, because one of them alone is not the total answer,” he points out.
- Execute your marketing plan when your target price is reached. “Pull the trigger!” he says.
- Review the results to determine what works best for your operation.
“It is natural to want to wait for better results when it comes to prices, but you’ve got to discipline yourself to pull the trigger,” Clark advocates.
Figure 1 shows the CME Group’s marketing alternatives chart.
Clark encourages pork producers to learn the fundamentals that drive the commodity markets by signing up for the CME’s Daily Livestock Report, co-authored by Steve Meyer and Len Steiner. Subscribe by logging onto http://www.dailylivestockreport.com/subscribe.asp .
Find free, real-time electronic quotes of the commodity markets
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