Summary
The basic Agricultural Commodity Markets will remain Volatile as long as the U.S. uses Corn for Fuel and the world continues to experience an emerging middle class in developing countries. Hedging can be a two edged Sword. Companies should manage to margins not markets. It is the Brands that Matter.
Analysis
As long as the U.S. continues to use Corn for Fuel and the middle class continues to emerge in developing countries the World Ag Commodities market prices will remain Volatile. For us Ag Economists types we see this continuing for the next few years. With that being the case, the world needs to find more acres to till and great pressure will be put on yields of familiar crops. In the long term, the world will discover other ways to make motor fuel more efficiently and governments will allow the most efficient producers of motor fuel extenders to export their products. In the meantime, users of Ag Commodities will continue to suffer from extreme price volatility.
General Mills, like other fine companies look at their firms and must protect themselves from going broke. To do this they will buy protection in the form of Hedges to protect the company. As the markets go up, the buy hedges look great. As the volatility moves to the down side, the hedges get marked to market as a negative. Therefore, as the markets go down, we see what can happen even to fine companies. The news from VeraSun(VSE) in the last two weeks is an extreme example of what can happen when "hedging" turns into panic buying.
These reasons explain why it is important for Firms to manage their businesses to margins. When they buy these commodities to hedge their products does it allow them to make a margin? It is time for CEOs of great companies to get involved in margin management in these volatile price times.
Great brands allow companies to pass on price increases during the up commodity cycles and hold those price increases through the down commodity cycles. The more the product sold is like a commodity, the more difficult it is to hold price increases. Cheerios has much more pricing power than does Ethanol.
Conclusion-- In the past commodity price fluctuations were not great enough to put fine companies at risk. That all changed in 2007 when Ag Commodity prices went to record high prices in just a few months. All Hedges eventually run out. Great brands will allow firms to give price increases and hold those prices for some time when markets turn down. CEOs should now be involved in Hedge decisions during these trying times. Those decisions should be margin driven. The better the brands, the greater the chance to keep margins.
