Perspicuous Risk

Over the years I’ve heard this term occasionally associated with risk taking; often used in lore associated with WWI. The odor of cordite providing a spurt of adrenalin to the emotion of either courage or fear. Futures trading, in a zero-sum atmosphere, is sometimes comparable to battle.

I credit Thomas H. Dittmer as the first using the phrase describing those often intense four hours and ten minutes from the first bell in the livestock markets to the closing bell in the grain markets.

“You and I are on the firing line. We know how to treat clients. We’ve taken hits. Clients want to make money. We know the risks. As you well know, our industry is full of dinosaurs. Things are going to change.”

That conversation was in 1974 or 1975. The spouse and I had arrived at Palwaukee in Tommy’s jet. A limo was waiting to take us toLake Forest.

Several mentors have passed through my life within a fifty year span in futures markets. The most memorable, without any doubt, was an association with THD. A bond of friendship was formed on that evening. Yes, we’ve had our rocky moments. But, within an environment of intense action and risk, big egos, creative minds and quick tempers, Tommy is a legend.

After a tour of their wine cellar, some discussion over a couple of glasses of wine and dinner for the four of us in their formal dining room a camaraderie evolved. This man was not the typical brokerage executive fearful of making bold decisions. A thread of commonality became evident : we both talked fast (time is money), we both began our days at 4 AM, we believed in preparation, a courage to make snap decisions, some good, some not so good, but if wrong, GMO (get me out). A written agreement was not necessary with Tom. His word solid. And, like most of us, just don’t ever cross us.

Tom is very high energy. His memory astounding. I recall a blurb in Fortune magazine in those days related to his memory and intellect. Anyone in the business of trading futures knows ‘you have to be able to count.’ I noted as that evening ended, we were completing the other’s sentences. There was an excitement in the wind.

While futures speculation is serious business, one of the pitfalls is taking oneself too seriously. Tom enjoys a great sense of humor; I knew his buttons, he knew mine. Over the span of our relationship, we’d lunch at the Pump Room or the Drake about once a week. When he purchased a wireless telephone system for his limo, he installed two phones. Those of us knowing Tommy recognized he enjoyed telling one party (aware he was traveling in the limo) “hold on, I’ve got another call on the other line.”

He always answered his own telephone. No calls were screened. Conversations were short (time is money) and to the point.

Those of us as professional traders (some now retired) also know those few exceptional visionaries able to move an industry into a new era are often controversial. Most folks dislike change.

In the days prior to platform trading, and beginning about 1965,many personalitiesbecame legendary. An electric excitement passed throughout the trading floor when one of these players walked onto the floor, or stepped into a pit. Hot line speakers soon installed in offices throughout the world, spread that electric excitement throughout the trading world.

 

Within some quarters the export grain trade is viewed as a mysterious craft.Often, in days long past, following a big increase in grain prices, I would overhear or read comments about the large profits earned by exporters.

In the real world any candidate for employment choosing to articulate his/her expertise in forecasting grain prices would continue to be interviewed in professional and gracious fashion, but after the hand shaking and goodbyes, the resume of this candidate would land in the waste basket before the front door closed behind his or her exit. The candidate quietly dismissed as a ‘crackpot.’

The primary goal of any seasoned, well-managed firm in the grain business is to REDUCE RISKS to a selection of alternative strategies. The act of speculating upon the direction of flat price levels of a commodity does not fall within the boundaries of sound management.

As I evidenced some skill and financial wherewithal, I was allowed to speculate in a small way in non-grain futures. Trading in grain was prohibited. I maintained a set of charts of various markets. One day, I brought a chart to the attention of a senior officer. He grabbed it; held it upside down, then sideways and chuckled. His interests were limited to: risk, turnover, carrying charges, cost per unit, buy discounts-sell premiums & use futures only if a profitable offset was unavailable in the FOB market.

I write this based upon experience prior to consolidation in the industry and before the availability of futures options and swaps.

The industry protocol was loyalty, secrecy, gather intelligence, and again above all, secrecy. It was okay to be seen in the company of competitors at meetings, but eyebrows would be raised if a friendship became a bit cozy.

There are opportunities in the export grain business. However, they are not available to a newcomer, or an outsider, unless he/she brings an understanding of the legitimate economic functions of the industry and an ability to undertake financial risks.

I would like to dispel what I perceive as a gross misunderstanding. It should be no surprise to learn that there is no “easy money” in the grain trade any more than there is “easy money” in farming or “easy money” in running the local hardware store. To illustrate this more precisely, I outline some of the considerations, economics, costs, and pitfalls associated with trading export grain within my frame of experience.

In my opinion,the potential of success relates to natural advantage. If you have no natural advantage in marketing grain, you must create such an advantage. If you prefer, substitute the phrase “legitimate economic functions” for natural advantage. The meaning is the same. Grain trading is merely the act of managing a sequence of legitimate economic functionsto result in the lowest per unit cost.

If you have scores of offices around the world, you may have a natural advantage. The more so, if you are also well-entrenched in finance, barter, ocean transport and foreign exchange operations. These advantages can be used to underwrite trading risk and to further vertically integrate.

It is not always necessary that you employ these advantages, only that you have them available. If you are performing your job correctly, for instance in ocean freight, your own vessels may never be available when and where you need them for grain, but they provideinformation and profits to underwrite adjacent functions. In other words, you need not directly employ each step of vertical integration to secure its benefits.

As example, it is only important you hold the alternative of using your own facilities, just as it is important to have the ability to make or take delivery on hedges.If you have a port elevator, it may occasionally be more profitable to sell elevation capacity to others and buy your own coverage CIF or FOB from competitors.

The point: you attempt to maximize profits on each service function. If you can limit risk-taking exposure to service margin profit, you will better survive the lean times.

For example, if you own river houses, lease barges, maintain a port elevator, operate vessels, lease discharge facilities, perform your own stevedoring, forwarding, hedging, contract execution; cover your own insurance, provide full out turn insurance, handle your own foreign exchange, originate, package and disseminate most of your own information you have perhaps a 2% margin of error on trading decisions.

Alternatively, if you decide to participate in just one segment: to justoriginate corn and sell FOB gulf, you may have two cents interior margin, two cents on the barges, and two cents fobbing margin. In other words, you could sell at a six cent margin. OR,you could risk two or three cents of your margin to make a more profitable CIF sale overseas.

Suppose, for example, you have sold a May shipment cargo of corn CIF toMoroccoin Euros.In doing so, suppose you gave up two cents per bushel.

How can you recoup the two cents per bushel?

You are long May Euros; You are lending money for three weeks at 3% over your cost of funds; You are short full outturn guarantee; You are short marine insurance; You are supporting your Morocco sales agent with ¼ percent commission; You are selling freight at $$ LT Gulf, or $$ St. Lawrence, or $$ from the Lake head: You are selling trimming and stowing services at three cents a bushel; You are selling a seaboard elevation at eight cents a bushel.

You are selling cash corn delivered to the Gulf for May loading on an ocean vessel premium over Chicago May Futures with equivalent values out of theAtlantic, St. Lawrence,Chicago,MilwaukeeorToledo. You are selling May futures.

You have gaineda lot of flexibility. Flexibility to cover the cargo in terms of individual functions. Flexibility to play upon the shifts in the basis and/or ocean freight. Flexibility to ship from Houston, or New Orleans, or Baltimore/Norfolk/Philadelphia, or St. Lawrence ports, or great lakes ports.

This flexibility can be worth several times the two cents cost.

In the advance stages of integration total profit should exceed the sum of margins from each operation simply because the risk-taking results become manageable. In other words, the value of the whole is greater than the sum of its parts.

Two corollaries worth mention.

In a seller’s market almost anything works well as long as you buy first and sell later, but in a buyer’s market vertical integration is survival.

The grain trade is management intensive. It does not run well when left alone. It is a business of exceptions. The interplay of all economic functions must be managed to maximize profits. The beneficiary is not only the grain company. The Ag producer also benefits. Benefits because it is a discount marketing system. Competition forces the discounts. The exporter may lose a few cents or the exporter may pick up a few cents but the producer gains access to the international market at less than full cost.

Compare this to other countries with highly regulated or government owned factors in the marketing channel. There is no competition. There is no discount. There is no discount because there is no profit incentive; therefore, there is a relative disadvantage for producers in most other countries.

Okay,we are on top of our game. We have a diverse book of sales. We are in great shape. Life is good.Enter Murphy.

Murphy ’s Law states, “Anything that can go wrong, will eventually go wrong.”

I was not personally involved in this example transaction; but I was very familiar with the mess. There are hundreds of lesser pitfalls. Point: everything must more or less proceed to plan in any particular sale to produce a profit.

In late 1974,Toprak, the official Turkish government buying agency purchased 500,000 MT of US wheat. Several companies participated.USwheat was sold for payment in foreign currency for deferred positions. The market was at a high price level at the time of sale. The dollar was firm.I presume all of the sellers hedged their foreign exchange by selling deferred currency and also hedged their wheat by buying deferred FOB Cargoes orwheat futures. The freight market was tight and most companies were booking either consecutive voyages or time charters. But no one worried about Toprak. Toprak is first class. Nice people, easy to trade with, honest as the day is long, and so forth.

Later that year, theUSAcut off arms shipments toTurkey. The Turkish poppy growers were unhappy with our continuing intervention. Also, early in 1975, the wheat market started to fall sharply and the outlook for new crop Turkish wheat improved dramatically. By spring of 1975, the Turkish purchases were: Not Needed, Were priced More than a dollar a bushel over the market, Embarrassing to the Turkish government because of the deteriorated relations and also embarrassing because of the high prices.

The Turkish parliament, after considerable debate, passed a law prohibiting letters of credit to be opened to pay for the wheat unless such letters of credit were at the current market.

Enter Murphy and LOSSES: foreign exchange short below the market. Losses on wheat longs above the market, losses on vessels time chartered at much higher than prevailing rates.

Tuesday, Wednesday & Thursday: Grain Origination Flexibility, Inverses & deliveries & Producer Marketing.