“Risk” is a catch-all term that encompasses many unique threats to traditional forms of wealth. Whether it’s political unrest, hyperinflation, or inclement weather, producers and speculators alike take an active approach to managing risk on a daily basis.
“Systemic risk” is a specific event or organizational collapse that may send a shockwave through a particular sector or sectors of the economy. Governmental, financial, and corporate failures top the list of circumstances detrimental to a wide range of industries. The global credit crisis of 2008 serves as a stark reminder of just how costly an untimely meltdown at the institutional level can be.
The good news is that futures products can be useful in limiting the impact of systemic risk on your business or market position. Whether you’re involved in agricultural futures trading or hedging financial risk, adding some protection at an opportune time is a proven way of protecting hard-earned wealth.
Agricultural Risks
Many systemic risks are capable of destroying the profitability of an agricultural producer. Credit freezes can hurt the bottom line as much as a severe frost, negatively impacting the availability of capital and next year’s crop yields. Even though commodity pricing may be strong, obtaining the necessary financing for conducting business can prove impossible.
In order to address these threats, hedging techniques using the futures markets are available to limit exposure. Here are a few examples:
- Becoming active in the debt market can provide insulation against a credit freeze or escalating interest rates. You can take long or short positions in U.S. Treasury products to manage risks facing an upcoming capital structure.
- Taking delivery on physically deliverable futures contracts — such as wheat, corn, soybeans, and rice — can help maximize proceeds from the cash market at a later date.
- Opening a conventional long or short hedge to offset a position in the cash market is a time-tested method of hedging against crop price variations come harvest time.
By its very nature, food is the ultimate safe-haven asset. In times of strife, food prices shoot up as people stockpile in anticipation of worst-case scenarios. The global credit crisis of 2008 is a recent example of this phenomenon, when the price of rice, wheat, corn, and soybeans spiked dramatically. However, successfully managing the systemic risks in the lead up to 2008 was necessary to efficiently deliver a product to market.
Financial Risks
Whether you’re trading currencies, commodities, or equities, hedging with futures may be able to provide insulation against many risks specific to the financial arena. Inflationary pressures, a failing domestic currency, or an economic downturn undermine most investments in the capital markets.
However, several safe havens are readily available on the futures markets:
- Metals: The most traditional safe haven in all of finance is gold. Silver and copper are also popular risk-management assets due to their affordability and utility. Because buying and holding physical metals on the spot market poses several challenges, trading metal futures may offer a convenient alternative for converting assets into cash or diversifying a portfolio.
- Commodities: In an inflationary cycle, energies and agricultural products typically perform well. Because demand drives commodity valuations, hard currency and debt instruments commonly lag behind commodity prices. Implementing a commodity risk-management plan can be a great way to minimize the impact of inflation on a portfolio.
- Foreign currencies: The foreign currency trade is an opportune venue for hedging against a global economic downturn or lagging domestic currency. The Japanese yen, Australian dollar, and Swiss franc are considered safe haven assets due to their insulated domestic economies. FX futures products based on each of these currencies offer distinct advantages over trading them on the forex markets or holding physical banknotes.
Using the 2008 global financial crisis as a reference, traders and investors dove into many futures products for relief amid a plummeting stock market and lagging U.S. dollar. By far, the preferred asset was gold, which posted more than an 8 percent gain for 2008, while the DJIA fell by 33.8 percent.
Getting Started
Finding a port in the storm is one of the most important aspects of capital investment. No matter whether you’re hedging financial risk or purchasing grain contracts to reduce exposure, a comprehensive strategy is necessary to achieve a desirable result.
If you’re interested in looking into the value safe-haven futures products can bring to your portfolio, reach out to the team at Daniels Ag Marketing. By developing a customized marketing plan, your core business may be insulated from many systemic risks.
