Understanding needed in reaction to price swings

by Morton Sosland
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As the influence of Russia’s grain crop disaster on wheat markets waxes and wanes, all too often expert analyses and even simple conversations about what this may mean reveal an abysmal lack of understanding about the economics of grain-based foods. Hardly anything is more galling, and perhaps alarming, than the frequent assertion that since wheat accounts for only a minimal part of the cost of producing a loaf of bread, advances of 50 per cent in flour prices should really have little or no effect on retail bread prices. Another equally specious assertion is to blame the rise in wheat on speculators while at the same time hinting that if bakers had hedged successfully any upward price pressure would have been avoided.

While no one disputes that many different costs go into delivering a finished loaf and that this cost array means that wheat flour is only one of many, the point so often overlooked is how narrow, even tiny, is the baking profit margin. As a result, the dramatic rise in wheat flour, as experienced at a near record pace in the past several months, means that the failure by bakers to raise prices erodes already minimal profitability. Modern baking operates on such narrow margins that prices must be increased in response to such dramatic cost upturns.

If that is not happening, and such moves have not yet been widespread, the credit or the blame largely belongs with retailers who resist price increases even while recognizing the urgency for their bread suppliers. As food retailing has moved into fewer hands, one alternative for wholesale bakers is developing and promoting products with flexible pricing. This helps explain recent accelerated growth of whole grain products. Like the embrace of variety bread decades ago, bakers understand that specialty bread, including whole grain, offers pricing advantages.

Stock market reports attempting to explain how the Russian wheat situation may affect the bottom line of publicly-listed food and baking companies have spoken of hedged positions that should forestall the impact from the wheat climb as well as companies that did not hedge. What many analyses neglect are the great difficulties inherent in hedging. Hardly anything has become more challenging for bakers in recent years than adopting strategies in anticipation of price moves that do not occur. That is especially telling for bakers who maintained long positions in futures in 2009 after the 2008 wheat market explosion, only to suffer the ignominy of hedging losses. It is little consolation to realize that much of the recent management uproar at General Motors Corp. was the result of huge hedging losses in rare minerals where the board of directors was not informed of this exposure. Hedging choices have become a minefield for baking management that require not only superb management skills but also seeking expert advice.

Partly because of problems related to hedging and the inclination among bakers to assert that hedging is not the same as speculating (often translated as gambling), bakers and their spokesmen usually blame speculators for the sort of wheat market moves experienced in the last several years. Without denying how trading volume has escalated to unprecedented levels, even with crop and disappearance volumes not much changed, and that this is largely explained by non-commercial trading, it is ill-advised to hold that trading lids would prevent such price gyrations. Futures trading is regulated, and, indeed, regulation is being increased in the wake of new laws and rules. That should be sufficient to protect against attributing seemingly inexplicable price move to speculators.

The awareness of bakers, as well as all in grain-based foods, of the potential problems and missteps in hedging should prompt a positive attitude toward expanded market participation. While this may magnify price swings it also expands the very desirable efficiencies of the market in price determination — in futures pits as well as on the shelves of grocery stores.

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