Commodity Hedging-The Double Edged Sword

Implications: With ever rising commodity costs food companies that have hedged their key commodity purchases with forward buying have done quite well over the last year.Several key manufacturers have announced that they have hedged their raw materials by forward buying 60-70% of their 2008 needs.Lost in the discussion has been the potential for commodity prices to go down in the latter half of 2008.

Analysis: As with any commodity like oil and precious minerals,speculators have the ability to drive up prices in the short term.General Mills reported a strong quarter recently with a substantial gain being delivered because they hedged their commodity purchases at favorable prices.

However, investors and companies need to realize that hedging can be a double edged sword if commodity prices drop.In the oil market experts estimate that around $20 per barrel of the price is due to speculators.That same phenomenon may be occurring in the grain and other food commodity markets.

For food companies its important that they lock in the raw materials so they have ample supply of the commodities they need to produce their products.However, they should not be in the business of trying to book additional gains based on commodity speculation.It will be interesting to see in the 2nd half of 2008 if commodity hedging is still a hot topic. It may be, but it could have the potential to be a drag on food companies earnings not a benefit.Commodities are very volatile lately and have as much potential to go down as their potential to go up.