What we know and what we don’t

Perfect information isn’t possible, which is why having a plan is so important

If you’ve ever read any Malcolm Gladwell books, you’ll know that he makes some very insightful connections across different topics. In the process, he uncovers some underlying fundamental truths about how people and our world really work.

His most recent book, Talking to Strangers, makes you think about how we deal with the unknown and manage uncertainty. It makes you realize that our opinions are sometimes wrong, that we have biases and preconceived notions, making it too easy to jump to conclusions. Often it’s because we take things at what we think is face value, but maybe what we are looking for is not actually there.

It can be hard to tell what’s real or not, what’s fact vs. fiction, and even more so in the heat of the battle. It’s good to be questioning things and have a healthy dose of skepticism toward things. The book points out that typically “we start by believing. And we stop believing only when our doubts and misgivings rise to the point where we can no longer explain them away.”

Those who can put themselves in another person’s shoes to take an outsider’s point of view or play a devil’s advocate role are better able to question things that many of us take for granted. Gladwell’s point is that “we will never know the whole truth. We have to be satisfied with something short of that. The right way to deal with uncertainty and the unknown is with caution and humility.”

All this has a direct connection with the markets and trading. As we all know, markets are filled with uncertainties that can’t be completely understood. There’s always information you don’t know about, or upcoming agriculture reports and economic releases. Then, of course, how traders and investors react to that information is another variable that’s in a constant state of flux. Doing as much research and analysis as possible will help but you still need to be open to all possibilities.

It’s for these reasons I’m a technical analyst at heart and why I like option-based hedging strategies. Technical price chart analysis is just the visual interpretation of market behaviour encompassing all news, research and economic business activity by all investors, trader and hedgers for the purpose of forecasting futures price trends. It is an illustration of the cumulative fear and greed of the marketplace. There are many valid price patterns and trends in financial markets that persist over time.

Unfortunately, as pointed out in the book, humans also believe they see things that aren’t really there. Likewise in the markets, there are many “price patterns” that catch the eye and the imagination which don’t have any worthwhile or predictive value. So, since charts don’t always easily reveal the future, options give you flexible hedging strategies to better manage the uncertainties of pricing your farm commodities.

Consider the recent canola environment. Last year when canola started breaking above $500 per tonne, heading toward multi-year highs of $525 to $540, a lot of people were keen to price some canola. And while no one saw this explosive uptrend coming, option strategies earned their keep as a valuable strategy to protect the downside and buy some time to see if the rally would continue. The $15 or $20 per tonne invested in option premium could very well have been the best money you ever spent. Eventually, you might have been able to sell your physical canola at $700/mt or $800/mt.

Bottom line, with this year’s new-crop canola already at $650/mt, it’s possible prices increase $100/mt, $200/mt or more to $750/mt or even $850/mt. But with a lot of weather and growing ahead of us, no one wants to commit too much production for delivery. Alternatively, if we get perfect growing conditions across North America and demand suddenly drops, it’s possible we’re back down to $500 a tonne. Remember, never say never. Regardless of which way canola goes, even in this sharply rising price environment, option-based hedging strategy can complement your physical sales to diversify your overall marketing plan. Once again, it could be the best $25 or $35 you’ve ever spent.

About the author

Columnist

David Derwin is a commodity portfolio manager with PI Financial Corp. The views here are his own, presented for educational purposes, rather than as specific market advice. For a copy of the complete research study “Farming Big Data — Myths, Misperceptions & Opportunities in Agriculture Commodity Hedging” contact him at [email protected]

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