Daily Archives: July 22, 2012

Markets are Unpredictable – Is It Time For Old Fashioned Futures?

Recently, the Economist published a piece about the broken record that the markets have been following for the past five years. In particular, it has been skipping between two tracks – total chaos (as we experience one crisis after another) and a rhythmic predictability (as investors flee to the safest investment vehicles around, a sharp contrast to the early noughts when risk was everything and traders made millions on the press of a button).

According to the article, an ideal portfolio in 2007 would have been stuffed with gold, white sugar, Swiss francs and German bunds, anyone holding that mixture of assets when the crisis began would have seemed either eccentric or confused. However, over the past five years, a new kind of risk aversion has seen gold hit record values on almost 10% of trading days. So has the Swiss franc, white sugar, and government bonds.

At the same time, many other currencies and commodities have hit record lows as well as highs. Hedging, the standard trick of attempting to offset potential losses/gains that may be incurred by locking in a price too high (or low) for a desired commodity by also taking a position in another commodity that has traditionally followed a mathematically defined relation with the desired commodity, has become almost impossible as one crisis after another derails any and all attempts to find predictable trends.

However, before hedges, we had good old fashioned futures. Initially designed to allow a farmer to sell his crop for a fixed price before it was even planted, a future provided a farmer with an assurance that he would be able to sell his crop without losing the farm if markets went south. This not only benefited the farmer, but also benefited the buying company as they would be assured of a product at the time of harvest. Or, if they didn’t want it, the buying company could sell the contract to someone else.

In today’s volatile market, hedging is not the best idea. If you can’t lock a contract in at a fixed price, which should be your Supply Management organization’s number one goal, you should look to a futures exchange. While it won’t offer either party as much security as a good old fashioned contract, a futures contract may prevent either party from losing their shirt.

Any differing thoughts?