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The Hedging Corner: Smart chocolate

In the previous Hedging Corner, we discussed how big banks made small fortunes by capitalizing on rising commodity prices while non-hedging manufacturers took a hit. Ironically, the big banks did the very things manufacturers are capable of doing. But that was the 1st quarter -- now what? Are commodities done punishing non-hedging manufacturers and their customers? Not according to smart hedger Nestle.

. Nestle sees commodity prices moving higher, but they're ready for that.

Nestlé Sees Higher Commodity Prices (WSJ, 8-June-11)

"A Nestlé executive said the Swiss food company is facing unprecedented increases in prices for raw materials and expects the situation to continue for the next few years. Kevin Petrie, Nestlé's head of procurement Tuesday, said speculators, weather conditions, and rising oil prices are ramping up the prices for cocoa, coffee, and other ingredients the food company uses in its products.

"In nominal terms, we are seeing unprecedented rises in the price of commodities," Mr. Petrie said at the company's annual investor seminar. "We see tremendous volatility and headwinds."

Nestlé has set up commodity research teams to identify trends, while the company uses futures contracts and hedging to lessen its exposure to price swings. "The tremendous volatility gives us an opportunity to take positions and cover the risks," Mr. Petrie said.

The commodity teams also produce a six-quarter outlook on prices. "We are always managing 18 months ahead. Because of the volume of these commodities it is crucial for our managers to understand the prices of the commodities."

Nestle's approach is stellar. The company has identified its commodity price risks and established an excellent risk management policy for controlling them. What do you think of Nestle's approach? More important, what are you doing about the prospect -- or likelihood, in Nestle's opinion -- of continued volatility and high resin and other commodity prices for the next few years? For many of you, the answer continues to be "nothing". What's holding you back? I asked that question last time. Here are some answers I received:

"Clueless" - "It's difficult to argue the benefits [of hedging] with the clueless. The greatest speculation is to do nothing as you are clearly speculating that prices are going down; otherwise, you'd have a position."

"Too busy" - "Most are so caught up in managing the day-to-day of their businesses----the guy with the sick kid who can't work his shift, the insurance salesman who shows up unannounced to pitch something, the calls with customers, etc. It's almost impossible to find time to strategize." PT's own Matt Defosse

"Fear of making a mistake" - you already did by not hedging and, if Nestle is right, the effects of that mistake will get worse.

"Don't know where to start" - start with the Rules.

"The boss is 'old school' and if I mention hedging to him he looks at me like I have lobsters crawling out of my ears." - is the boss a brontosaurus?

Smart hedging beats layoffs and low-to-no profits. Follow Nestle's lead. Get with the [hedging] program ... and enjoy some good chocolate while you're at it.

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