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The Hedging Corner: Manufacturers take a hit, big banks cash in

 "U.S. manufacturing growth slowed substantially in May, as the ISM index fell to 53.5, the lowest level since September 2009. ... higher commodity prices and a sharp decline in automobile production cut into manufacturing growth and put a chill on hiring." Bad news, that, as reported by the Wall Street Journal in its article, High Commodity Prices Slow Manufacturers (WSJ, June 1, 2011).

 "U.S. manufacturing growth slowed substantially in May, as the ISM index fell to 53.5, the lowest level since September 2009. ... higher commodity prices and a sharp decline in automobile production cut into manufacturing growth and put a chill on hiring." Bad news, that, as reported by the Wall Street Journal in its article, High Commodity Prices Slow Manufacturers (WSJ, June 1, 2011). [See related articles here and here on PlasticsToday.]

Manufacturers didn't have to take a hit due to higher commodity prices; but they chose to - at least those without a hedging program did. Are you among those manufacturers? Isn't manufacturing in the U.S. hard enough without allowing the cost of resins, energy, and other commodities to dictate your success and, ultimately, determine if you stay in business? Drop the fiddle and take the wheel. Establish and implement a smart hedging program.

Compared to manufacturing with all its complexities, hedging is easy - and smart business. Take a lesson from the big banks. Unlike manufacturers, they don't have a fundamental business reason to trade or hedge commodities. Higher commodity prices don't hurt a bank's bottom line. Big banks have simply learned how to trade and manage risk within a set of rules, and then take advantage of the commodities markets -- i.e. make money. Making money trading is a lot harder to do than just managing risk, which is all manufacturers need to do.

Big Banks Cash In on Commodities (WSJ, June 2, 2011)

 "Wall Street is tapping a real gusher in 2011, as heightened volatility and higher prices of oil and other raw materials boost banks' profits. A group of 10 large banks, including Goldman Sachs, Morgan Stanley, J.P. Morgan, Citigroup, Bank of America, and Barclays, saw their commodities revenues increase by 55% in the first quarter. So far this year, oil and other commodities have gone through wild gyrations. Crude oil's volatility level shot up to a level unseen for a year, according to the Chicago Board Options Exchange. As prices move up and down sharply, oil producers and airlines that want to lock in their profit margins or costs are turning more often to banks for hedging help."

Manufacturers don't need to turn to the banks for hedging help, but that's better than hunkering down, hoping you outlast the competition, your customers survive, and commodity prices magically fall. The best approach is to "do-it-yourself" after establishing hedging Rules. What's holding you back?

Traders at big banks and elsewhere aren't smarter than you - and they're not bad guys. They're just risk takers who know how to trade and manage risk within a set of rules. If you're a manufacturer in the U.S., you're a bigger risk taker than traders are. But you're taking unnecessary risk in commodities, and paying dearly for it. Learn how to manage risk by your rules, and then do it.

About the author: Tom Langan is a risk management and trading consultant who operates WTL Trading. He specializes in commodity cost control, loves to trade options, and enjoys teaching others ways to protect and increase the value of their manufacturing and personal portfolios. He has worked with private and public entities, as well as individuals, in helping control and take advantage of volatile oil and gas, electricity, resins, and metals prices.  More background information here.

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