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Farmers should hedge to protect income
This article appeared in Country-Wide southern edtion March 2004 and was written by editor Terry Brosnahan. Much of what is covered here was explained by Brent Rawstron to those attending the Entrepreneurial Farming and Environment; Being Green and in the Black conference. Bull beef farmers should consider using foreign exchange hedging to guarantee their income says Christchurch-based farmer and exporter Brent Rawstron. Rawstron, a former Meat Board director, has back-to-back foreign exchange cover for about half of the 200 odd bulls he finishes each year on the 145ha farm. He does this because they only go to the USA for grinding meat and the price he receives is almost totally influenced by movement in the exchange rate. “Obviously you only want to hedge when the dollar is going up not down and the aim is to guarantee your income.” Rawstron has been hedging his bull beef for several years, ever since the dollar went “silly.” He uses a hedging facility provided by the National Bank rural division. Half of the bulls are covered with hedging because the rest are contracted. Cover is taken out when the bulls are bought in as yearlings. It is taken for 12 months at which point they will be finished and killed. He says the longer a hedging contract is taken out the better the rate will be. If for example the dollar is at 70 cents the hedge will usually be a cent or two lower than that. It costs him no fees to take out the bank’s farming hedging package but the bank places a stop-loss position on the currency deal. That is, if the cover was taken out at 70 cents and the dollar starts to fall, the stop-loss option may be at 65 cents to minimise the loss. If the dollar keeps dropping below 65 cents the farmer only has to make up the loss for the five-cent drop. If for example his 100 bulls were worth $1000 each and he took out currency cover at 70cents it would be for $NZ100,000 (ie he has a contract to buy $US70,000). If the dollar rises to 75 cents the schedule will start to drop to below $2/kg, so he kills the animals and sells the currency. The loss on the schedule price would be made up by the gain on the exchange rate. Another option with hedging is to use a Currency Option which is like insurance. A farmer buys a Currency Option for say $US70,000 and has the right to sell that amount of currency at a set exchange rate and date in the future but will only do so if it is profitable. If the dollar moves against the farmer he does not have to sell and the only cost is the premium paid to the bank for the Option. Rawstron does not use the Option because the premium is too expensive. He says every time the currency moves one cent it equates to about a nine-cent movement in the schedule price. He always works on one cent currency equalling a 10 cents/kg movement in the schedule as it is easier to calculate. So when the dollar went from 50 cents to 60 cents about a dollar was knocked off the schedule. If he bought cover at 70cents and it went to 60cents the losses on the currency would be covered by the gain in the schedule price. Rawstron and his wife Shirley also export grass-finished beef and wine from their 5ha Rossendale vineyard which is also on the Halswell farm. They also own about 30ha of grapes in Canterbury and Marlborough in partnership with other wineries. About 700 cattle are finished on the farm each year (400 at any one time) of which 200 is bull beef, the rest are for the prime market. They sell the prime cattle to Canterbury Meat Packers on schedule and buy back three cuts-strips, tenderloins and ribs to export to Germany. The cuts are about 5% of the carcase. The beef is sold for $NZ100/kg to International coffee house Alois Dallmayr a specialist deli in Munich which handles 10,000 table-related items. Foreign exchange cover is not needed for the meat they export to Germany. If the dollar moves up the schedule price falls and the meat they buy back drops in price so there is a bigger margin in selling to Dallmayr. Rawstron says the exchange rate is not a problem when exporting their beef to Germany as they have three different scenarios. They grow the beef, sell it on schedule to freezing companies and buy back on export schedule per cut to sell in Euros to the client. “There are three sources of profit and loss in the transaction. In any scenario all three can not be negative, one must be positive.” Rawstron says if he was just farming bull beef he would be hedging a lot more. The Rawstrons are dealing with currency all the time with their wine exports which go to the United Kingdom, USA and Germany. The cover taken out is in the currency the wine is retailing at. This way if the dollar fluctuates the retailer does not have to keep adjusting the price. “If it is in NZ dollars the price would be changing every shipment. Supermarkets like Tesco which have hundreds of stores would have to keep changing their till every month and they won’t do that.” The Rawstrons are not taking forward cover on any product at the moment, as they have foreign currency bank accounts into which they deposit their funds and receive interest in the currency of the account (eg British pounds). They will hold that money until they see an appropriate opportunity to convert. “For instance we may set a trading value of 0.3550 as acceptable for GPD (currently 0.37) and place a purchase order with the bank to buy say 50,000 pounds at 0.3550. Once that is achieved we will use the funds on deposit to affect this transaction and convert our pounds for product sold at that time.” Most farmers are not exporting, the meat companies are. Unless they are covering contracts with suppliers the companies do not hedge. Rawstron says while meat companies do not take out foreign exchange cover because of cost, farmers have a mechanism available to do so. If a farmer thinks the currency will go in one direction he could also become a gambler by locking into a contract (which a meat company will have protected with hedging) and take out currency cover as well. But Rawstron takes cover to guarantee income not to trade in currency. A trader buys and sells currency to make profit. What Rawstron is doing is protecting his income, the $NZ100,000 on 100 bulls. “The single biggest one factor that can change my return is the US dollar.” Other factors that influence the price farmers receive tend to be long term trends such as the build up in the US beef herd, the impact of climate and consumer demand. He says farmers should keep an eye on these trends by reading newspapers and the information put out by the Meat Board. “Keep an eye on where we are in the cycle of selling beef. Is New Zealand’s 300,000 tonnes of quota to the USA nearly full?” If it is nearly full but in December it is not a problem as exporters will continue shipping the beef and keep it in bond as the new quota year starts in January. If it is a long way out If a farmer’s 100 bulls were worth $1000 each and he took out currency cover at 70 cents it would be for $NZ100,000 (ie he has a contract to buy $US70,000). If the dollar rises to 75 cents the schedule will start to drop to below $2/kg, so he kills the animals and sells the currency. The loss on the schedule price would be made up by the gain on the exchange rate. If a farmer buys a Currency Option for say $US70,000 and has
the right to sell that amount of currency at a set exchange rate and
date in the future but will only do so if it is profitable. If the
dollar moves against the farmer he does not have to sell and the only
cost is the premium paid to the bank for the Option. |