Market Check’s Head of Strategy, Nick Crundall, discusses how best to manage grain price risks in a volatile market.

Volatile Markets

The grain markets are becoming more and more volatile, as a cocktail of historically tight supply and demand fundamentals mix with an increasingly chaotic geopolitical situation. Volatility can be hard to handle, and even harder to manage when it comes to making decisions around grain marketing. Over a quarter of a century of working hand-in-hand with Australian growers, there is one underlying principle we see at Market Check that separates those who consistently outperform the average (irrespective of size), and that is a principle called Risk Management. These higher performing growers focus just as much on the risk of prices falling, as they do about the potential for prices to rise. Using the principles of risk management as the foundation of your grain marketing will not only de-stress the entire process but result in consistently better returns over the long run. Luckily, risk management is something that can be implemented instantly and simply – it’s only a change of perception. It is more to do with the psychology of how we approach grain marketing, while adopting these principles will raise you above the vast majority of the grower community in terms of returns over the long run.

The Pitfalls

A common pitfall that almost exclusively ends in tears is trying to trade or time the markets. Trying to pick the top of the market to sell, or avoid selling at the bottom is a fool’s errand. Way too much time and effort is devoted to trying to time grain sales when prices might be hitting their peak. People devote their entire careers and vast sums of capital trying to speculatively time the market, and those few who succeed only pick winners a little more than half the time. What chance do the broader farming community have of consistently timing the market amidst everything else that goes with farming? As marketing advisors, Market Check come across this frequently, as new clients want us to tell them when the prices are at their highs, or when we put a bid in front of a client, only want to sell ‘if you think the price is going to fall’ – these are examples of trying to pick the market, not manage our risk.

The other common mistake is thinking in a binary fashion. Everyone can have a view on what prices might do going forward – it’s natural and plays a part in most people’s strategies, including ours. Where the risk lies is allowing this view to trap us into binary decisions. For example, if you believe prices will rise, many growers will hold back from selling anything in the hope of this view coming into fruition. This means that you have 100% of your current/future production and therefore a large proportion of your cropping revenue exposed to this outcome– which is excessively risky. Your odds of picking the market are often no better than flipping a coin, so it’s akin to someone offering to bet you tens of thousands of dollars (a lot more in many cases) on the outcome of a coin flip. 99% of us would deem this way too risky, however we take similar chances on our grain marketing, mostly without realising.

“We need to change our perception/expectation away from consistently picking the highs, to consistently managing our risk. As famed investor Howard Marks put it “The point is to consider risk control, loss avoidance, at least as important as return.”

The Secret Sauce

Firstly, it’s important to not get hung up on our last sale. We need to zoom out and look at our grain marketing at the portfolio level. Let’s put this in real terms, a grower sells 250t out of 2,500t production and afterwards watches the price rise another $30/t and kicks themselves for making the sale – this is the wrong way of viewing it. In reality, sure there is an opportunity cost of 250t x $30/t = $7,500 that has been left on the table, but the remaining 2,250t yet to be sold has gained in value by $67,500 ($2,250 x $30/t). This should be viewed as a great outcome. Sure, it would have been better to do nothing, but prices might have fallen, and that sale would be helping offset your crop which has fallen substantially in value.

A great example is Put Options – which we advocate nearly every year. We so often hear a bit of a cheer when we inform our clients who, for example, bought put options over some of their Minimum Crop Estimate (MCE), the market falls and that put option is now worth more than the initial cost they paid to purchase it, i.e. it’s been a ‘profitable’ exercise. This is a quintessential example on having too narrow of a focus. If we break this down again, say we buy 500t of put options over our 2,500t MCE. The put option premium is $20/t and after we purchase the puts, the market falls $50/t. We have a net gain of $30/t ($50 minus the $20 premium spent) x 500t, which is $15,000 – which is often received as good news. The put options have done a great job of drawing a line in the sand and protecting that 20% of our expected production against lower prices. However, even with the put options, it’s a much better outcome if the market had rallied $50/t, resulting in the puts being worthless. We walk away from the $20/t we spent on buying (the now) worthless puts ($10,000), but our entire 2,500t is worth an extra $50/t ($50/t x 2,500t = $125,000). Profitable put options might sound great, but it would be a far better outcome if they expire worthless.

We need to change our thinking away from ‘I think prices are going to rally, so I’m not selling anything’ to ‘I think prices are going to rally, hopefully I’m right but just in case, lets sell 20%’. Our clients who adopt the latter consistently outperform those who are entrenched in the former. When the market falls and goes against the prevailing view (which it so often does), we have some protection (a 20% sale/hedge) in our portfolio to help offset lower prices for the balance of our crop. The cherry on top is this mitigates us from being under pressure to stop the bleeding in a falling market, which all too often results in a larger sale near the bottom of the market (as the grower is playing catch-up on their sales program).

This is not to say all we need to do is adopt the above to be successful, there is a multitude of other factors that need to be considered; what, to whom, and how to sell, to name a few. Risk management is not just selling in increments, in fact simply averaging sales into the post-harvest market has a poor history of returns – it’s about approaching our marketing holistically, recognising the risks and addressing them. Market Check has been advocating this approach for decades and helping growers achieve consistently strong returns. We have seen firsthand the powerful compounding effects it has on those clients who adopt it within their businesses.

Editor: Nick Crundall, Head of Strategy, Market Check