FX in grain marketing

[jdepape]

I really shouldn't waste my time on this but I feel quite strongly that the message about how FX is being managed in grain companies - and presented to farmers - is being distorted, misrepresented and ultimately misunderstood.

In this thread I am sharing some Guiding Principles regarding FX risk management in a grain hedge book that (hopefully) is understood by most grain traders in Canada. I hope it will encourage a better understanding of FX, hedging, and risk in Canada.

From a Canadian perspective, there are two types of FX risk to consider when trading ag commodities:
- risk exposure from <b>change in the CAD relative to the USD</b>, and
- risk exposure from <b>the fact that the CAD is simply not at par with the USD

[jdepape]

Guiding Principle #1 <b>(applies to wheat)</b>

FX risk exists when a trade is made in a currency other than the currency that the commodity’s value is truly determined.

<b>Wheat’s value is truly determined in USD. Even if you are buying wheat in CAD and selling wheat in CAD, you have FX risk.</b>

[jdepape]

Guiding Principle #2 <b>(applies to wheat)</b>

Convert the price of the commodity to the currency in which it is truly determined.

<b>From a risk management perspective, this does not mean convert the futures to CAD</b>

[jdepape]

Guiding Principle #3 <b>(applies to wheat)</b>

Flat priced CAD positions in US-valued commodities are hedged “pound for pound” in the appropriate US dollar denominated futures market, as well as with a normal FX volatility hedge.

<b> When you buy cash wheat, the full appropriate hedge is to sell wheat futures and buy CAD (interbank or futures) in appropriate amounts.</b>

[jdepape]

Guiding Principle #4 <b>(applies to wheat)</b>

For US-valued commodities, CAD basis positions are hedged by an opposite US-denominated futures position of a size equal to <b>(1-1/exchange rate) x cash contract size</b>, as well as a normal FX volatility hedge.

<b> This means when you buy wheat on a basis only contract in CAD, you need a proportional hedge in wheat futures PLUS an FX hedge – odd but true. </b>
This is an example of the “non-volatility risk I mentioned earlier. If the CAD/USD is at par, it’s not a big deal. But when the CAD is at 0.80, a $1.00 move in wheat futures means a change in CAD price of $1.25 – a price change that will affect the basis, not futures; the proportional wheat hedge protects for that.

[jdepape]

Guiding Principle #5 <b>(does not apply to wheat)</b>

In the event that a commodity is not US-valued, CAD flat price positions are hedged by an opposite US futures position of a size equal to <b>(1/exchange rate) x cash contract size</b>.

[jdepape]

Guiding Principle #6 <b>(does not apply to wheat)</b>

In the event that a commodity is not US-valued, CAD basis positions are not hedged in US futures.

[jdepape]

Guiding Principle #7 <b>(does not apply to wheat)</b>

For Canadian valued commodities, US dollar basis positions are hedged by an equal CAD denominated futures position of a size equal to <b>(exchange rate – 1) x cash contract size</b>.

[riders2010]

Haha we already know who s taking all the risk!!! In fact it's so common that I really wouldn't call it risk it's just the way it is we live bent over. I m getting a sore back from it though. Lol

[jdepape]

You will notice in all these Guiding Principles that there is no mention of hedging the FX risk in a US futures position (like Mpls wht). It is well understood that the global wheat market is determined in USD. Since the futures are in the same currency, a Canadian trader has no FX risk by entering a futures contract on its own, so no FX hedge on the futures.

All FX hedging activity should be on cash positions – flat price sales, basis sales, flat price purchases, basis purchases. FX risk management in a grain book is complex enough as it is – to suggest the futures should be converted to CAD (with no purpose from a risk perspective) adds a layer of complexity (and likely confusion for the trader) while adding nothing to the ability to manage the risk.

In wheat in Canada, the FX risk is in the cash price - <b>not the Mpls or Chgo or Kansas wheat futures.</b> Look at it from a trader’s perspective. Sometimes you want to get long commodities in Canada because you want to be exposed to a weak CAD. Buy canola futures and you will see them supported by a weak CAD. But, buy Mpls wheat futures and you get nothing out of a weak CAD. The <b>FX impact is in the cash price – which means it’s in the basis.</b>

It’s no surprise that, while the CAD has dropped from 0.86 to 0.79, the average CWRS basis in W.Cda has risen from -49 to 3 (cents/bu) – an improvement of 0.52/bu. The FX is in the basis – plain as day. Others factors may overwhelm it, but it is there.

Now – have at it. Tell me I’m full of it.

[cottonpicken]

What was Kennedy's quote about a farmer.

"sells wholesale,buys retail and pays the freight both ways"?

[bucket]

Guess we could solve the problem by having graincos write the cheques in US dollars.

That way the elevation and freight charges could be paid in usd which would cost them less as well. Oops . Gotta go find the tin foil.


Good traders and graincos view.

Sure glad you were hired by ritz to represent farmers concerns.

The outcome is a foregone conclusion.

[SASKFARMER3]

That's a good explanation now here is one back.
Why did Winnipeg fail. Why not make the grain companies use a price point we could all work off of.
Why the move to USA point.
Its easy one I'm seeing get the hell out of growing any wheat and giving it to the grain companies then.
Go with another cereal.
Kind of fun to drop HRS.
AH farming.
Their is an answer for every thing why we have to pay.
Ah shit I dropped the soap.
Ouch!

[Kodiak]

Thanks John. This forum needed that explanation.
Those wanting to reinforce the fact they are able to erupt and take cheap shots, will do just that. But the shots won't add any light to the discussion, just smoke.
But be assured the majority will read your posts enough times to understand what you are saying.
I know that for me your step by step explanation filled in some gaps in my understanding. The ranting that's gone on here for months sure didn't!
I appreciate your effort John - and the fact you have thick skin

[bucket]

Principle 1 thru 4 are all about buying wheat.


Take it a step further and make the cdn graincos the seller to the international end user buying grain.

It seems the graincos have nothing to say about that process. And that's because the farmers paid their fx risk up front.