Hedging Means Better Price Predictions
Research by Brain Coffey at Kansas State University shows hedging cattle can allow feeders to more accurately predict the final price they will receive. Coffey used price and basis data in Kansas over a ten-year period (January 2010-June 2020) to compare price outcomes on fed cattle with and without hedging assuming hedges were placed as soon as the cattle were put on feed.
Coffey found there was little difference between average prices received with or without hedging. In other words, hedging didn’t result in either higher or lower prices relative to unhedged cattle. However, Coffey said, the story doesn’t stop there—the key is comparing expected prices to actual prices received.
When placing cattle in the feedlot, feeders should have some expectation of the price they will receive for the cattle. Price expectations allow for decisions to be made whether to place the cattle. The price expectation could be based on the feeder’s knowledge and experience in markets; it could the relevant futures price at placement; or it could be the hedged price (futures price at placement + expected basis). The key is the difference between the actual price from the expected price when the cattle are sold. In other words, were the profit/loss expectations on the cattle realized?
Pegging the expected price is where hedging really shined according to Coffey. He found the difference between actual prices and expected prices with hedging were much less than the differences when predicting based on cash prices or futures markets. This is because predicting a price with a hedge is subject only to basis risk (a change in the relationship between the local and futures markets prices). Predicting the final price when not hedging is subject to both price and basis risk. Coffey concludes, “This is major benefit of hedging—producers have expected price predictions that are much more accurate and have the ability to plan ahead regarding profit/loss.” Hedging can be used to avoid large losses. Coffey found that over the 10-year period, simply predicting the cash price resulted in losses greater than $10/cwt. in 121 weeks, whereas hedging resulted in no losses greater than $10/cwt.
Preventing excessive losses can be a difference maker for long-term financial security. Coffey’s research suggests hedging can help in this regard. For more information go to: https://agmanager.info/livestock-meat/marketing-extension-bulletins/marketing-strategies-and-livestock-pricing/hedging
