INSIGHT
UPFRONT MARKET VIEW
Hedging bets on Singapore Words by: Stuart Davison
B
y the time you read this article, the NZX (New Zealand Exchange) and the SGX (Singapore Exchange) would have completed the transfer of NZX Dairy Derivatives from NZX to the biggest exchange in Asia, the SGX, completing a real boon for the NZ dairy industry, which has probably flown under the radar here at home. Obviously, this effort was not missed in our offices, as the NZX Dairy Derivatives team has tirelessly worked to complete the transfer. But, I know what you’re asking; how is this a boon for the NZ dairy industry? Well, let’s start by pointing out a few key points; our biggest region of dairy customers (or, end users) is Asia, which includes China and all of the other key South East Asian regions. China on its own consumes 41% of NZ dairy exports, and this trend is unlikely to change in a hurry. NZ historically has been completely exposed to commodity trend cycles, without any way to protect the industry from shocks that usually come from commodity production; think 20132014 price rise and crash. This is where financial instruments such as futures and option contracts come into the picture. I’m sure you’ve heard of the concept of “hedging your risk”, well this is one of the key concepts of having a derivatives market. This market is a place where buyers and sellers of a certain commodity can
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buy and sell a financial contract, tied to is only one part of Fonterra’s overall the underlying physical commodity, for derivative uses. So, if more buyers of a certain price agreed upon now that will WMP are willing to also engage in using trade at a determined time in the future. WMP futures contracts, then Fonterra This “hedges” both the buy and sell side’s can increase the volume of risk that it risk before the actual trade occurs; aptly can mitigate, while the buyer can also named futures contracts. mitigate their own risks. Futures contracts, which are This creates a much more financial derivatives, use this stable marketplace, as buyers basic concept to help manage and sellers are both more risk for those within certain engaged in price discovery. industries. There are derivatives This market also creates for almost everything you can a forward view of prices, imagine, ranging from sugar to as both buyers and sellers Stuart Davison. trade for timeframes into the coffee, oil to currency. Now back to how moving dairy future, giving a forward view of derivatives to SGX is a boon for the NZ intentions of both sides of the market. dairy industry. Local dairy processors, Speculation is also a key part of a Fonterra etc, and end users, such as derivatives market, where speculative Mengniu in China, use these contracts to traders aim to make profit from picking mitigate their individual risk exposure to which way the market is heading. the price movements of the underlying Speculation trading in a derivative market commodity. is like grease on a silage wagon, they Whole milk powder (WMP) futures help to keep things moving, creating contracts are the most traded dairy liquidity within the market, or the speed derivative on the NZX market, which is or quantity of trades within a market. By also NZ’s biggest dairy export. Moving this nature of its size, and financial maturity, market to the SGX exposes the contracts to the SGX has more speculative traders than more brokers, more speculators and closer here in NZ. to more end users, helping to balance the As the NZX Dairy Derivative market demand and supply for these contracts moves to the SGX, all of these facets better. combine to create a set of financial For a company like Fonterra, the ability instruments with more liquidity and closer to manage risk with a derivatives market to industry end users, that will help to deis paramount to reducing their overall risk risk the dairy industry, as uptake and use exposure. of these instruments grows. Everyone gets bogged down with The boon for the industry comes from Fonterra’s currency trading, but that increased price stability, a forward view of the market, along with derivative products that can be used onfarm, such as milk price futures, that will allow for risk management from every point in the production chain; the farm gate to the factory floor in China. All in all, a great step forward in maturing the NZ dairy industry, and growing resilience to price shocks into Sep 20 Mar 21 Sep 21 the future.
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Source: NZX
• Stuart Davison is an NZX Dairy Analyst.
Dairy Exporter | www.nzfarmlife.co.nz | December 2021
