Commodity markets are facing many challenges today with oversupply, low prices and uncertainties, making managing price risk a critical skill for financial professionals. The 2016 AFP Risk Survey from the Association of Financial Professionals revealed commodity prices are one of the top drivers for earnings uncertainty across industries.
Global economic instability and volatility have material impact on commodity prices and a company’s ability to contain costs and protect margins. Even though we are operating in a historically low-price environment, commodity markets are not immune to dramatic, often unpredictable swings.
In April, soybeans and corn rallied up as much as 13.7%. These prices did not move us far from historical lows, but the sudden market rally was surprising for many. To minimize uncertainty or maximize opportunity in these markets, it is critical to engage in risk management strategies that ensure you are well prepared for a sudden rise or drop in prices.
Having no hedging strategy is a risk in itself. Even if we do not know where the markets will be this week, a few months or years ahead, we can thoughtfully construct a risk management plan with our bias, experience and needs in mind. The goal is to feel confident that you have made the right decision for your company, in your markets, at this time.
Diversification is essential for overall risk mitigation. For years, hedging risk through the trading of futures and options was cutting edge. In today’s markets, risk managers seek greater ability to identify, assess, prioritize and manage price risk. To be effective, evolving strategies with more customization are utilized to manage exposure.
Pursue Dynamic Methods
Price points are impacted by a variety of factors and that means simply hedging risk through futures trading or a fixed instrument will not meet all needs. Tailored options, currency hedging, structured products and other customized solutions are coming into play more often. A strong hedging portfolio is not overly concentrated in any one of these methods, but utilizes the appropriate solution to meet needs, objectives and risk tolerance.
Take a Holistic Approach
When you are constructing your retirement portfolio, you are likely diversifying your exposures in stocks, bonds and equities to ensure you are not putting your security and livelihood at risk should the market turn. The same is true for a commodities hedging strategy – concentrating all of your risk mitigation in one or even two types of products does not offer the same protection. Instead, you are likely making less pragmatic decisions and responding to every market move – which is ineffective given how quickly prices fluctuate.
Utilize Various Counterparties
In the past, corporations might have worked exclusively with large banks to seek solutions. Today, companies seeking to diversify their counterparty risk have opportunities to work alongside non-bank organizations to achieve their hedging objectives. When seeking a partner in risk management, ensure they provide a stable balance sheet and reputation, while also meeting regulatory requirements.
We can’t control the markets, but we can make confident decisions, utilizing diversified strategies and a proactive approach to risk management.
Comments are closed.