Jan

6

When you look at markets that have natural long/short hedge interests (such as physical commodities) I think that there is an interesting point that occurs when movement in the market puts one side's (long or short hedgers) primary business at risk. In either late 2010 or early 2011 (I think around then), I looked up the quarterly reports of coffee processors/roasters and tried to get an understanding of how their hedge program was structured, and how they were dealing/had dealt with the price spike.

I remember one of the companies (A CA based roaster if I remember) talked about expanding their hedge program — they reached the "uncle" point where they needed to hedge out more risk "in case it gets worse" and motivated by that fear, started a program that was ultimately very costly — as costly as it was necessary.

And I know that for a period after that, once the bull trend faded, a very steep contango developed that was/has been quite persistent.

I read the Starbucks CEO's biography years ago. I remember him describing a horrible bull market in coffee, and how they ended up expanding the hedge program huge at just the wrong time in a way that (with hindsight) hurt profitability for years. They, in other words, hit the uncle point — and the continuing need to buy coffee meant they put that hedge premium into the market for years.

The above was not very articulate, but my point is that I think there is a sweet spot in speculation. When the other side feels forced to act, substantial premiums can set up on the other side that become persistent, and this can be partly seen and is reflected in things like the forward curve. Kind of basic stuff, but I think very useful when looking for large profit opportunities.


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