gmccon, Imagine yourself a farmer with a crop of wheat that you just planted but from which you expect to harvest 10,000 bushels in the fall. Obviously you can't sell it yet because you just planted it. You know that if all goes well it will cost you $1/bushel to bring it in. If you had the wheat in hand you could sell it for $3/bushel...profit $20,000. Enter the futures market. One of mans most creative inventions.
Many companies could use your wheat in the fall. General Mills puts in a buy order for 10,000 bushels of Dec wheat at $2.75. You decide that while you would love to get $3/bushel..$2.75 isn't bad. You decide to lock in at $2.75 and agree to sell 10,000 bushels at $2.75.
Bad weather causes widespread crop failure. Dec wheat goes up to $5/bushel. Too bad you get $2.75.
Record crop is forecast. In July, Dec wheat has dropped and is now quoted at $1.50/bushel. You're a genius. You still get $2.75. You save the farm. Money in the bank.
I'm not a farmer but I have a hunch that $2.75 for Dec wheat is low. I buy 10,000 bushels at $2.75. When Sept comes and Dec wheat is at $5/bushel, I sell my 10,000 bushels and close out my position (making $2.25/bushel).
You have the option of actually making delivery, or closing out your position..and then selling the wheat at spot price to a local grainery. (you would lose on the forward sale but make it back on the spot sale & thereby maintain the locked in $1.75/bushel profit)
As a producer of gold, Barrick is in the farmers place. They loved $400/oz and sold a ton. Someone (maybe a manufacturer) bought it thinking that gold was going much higher & they would make a killing when they resold it in 2001. They may yet but for now it looks like a BAD deal.
Hope this helps, Dave |
