Grain Investments Explained

Trading on SAFEX

The South African Futures Exchange (SAFEX), a subsidiary of the JSE, offers derivatives on a wide range of local and international agricultural commodities, including grain. Agricultural derivatives traded on SAFEX provide a platform for price discovery and efficient price risk management for the grains market in South and Southern Africa.

Grain Investment Explained

Investing in grain is much easier than most people think, and the process is not much different than opening a share trading portfolio at a registered broker on an exchange.

An investment in grain can be divided into two approaches. One would be to buy the physical grain and store it in a safe storage like a silo. The other would be to invest in soft commodities, buying grain indirectly through an exchange like SAFEX (South-African Futures Exchange).

To buy physical grain, you would not only require safe storage facilities of your own or pay someone a fee to store it on your behalf, but it is also expensive and only recommended if you have a thorough understanding of the physical grain trading market dynamics.

Alf Becker, CEO Heimker Investing says, “My preferred grain investment is the more “indirect” approach, investing in soft commodities on an exchange like SAFEX. This method allows grain investors to generate money when prices go up, sideways or down.”

According to Becker, although an investment in grain has a much shorter investment outlook – in most instances, not more than 12 months – it is possible to expand your investment over a longer period. The grain market offers a new investment opportunity every 12 months with the planting of new crops. The only fundamental left from the previous 12-month period, is the ending stock.

What are Soft Commodities

Soft commodities are the various products trading on the agriculture commodity market. These include coffee, sugar, fruit, livestock and grains such as maize and wheat, but also oilseeds like soybean and sunflower. These commodities present a genuinely attractive investment alternative to investors, depending on market conditions and the inherent dependence or interaction between the various soft commodities. Soft commodities play a major part in the futures market.

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The SAFEX grain market

The SAFEX grain market has developed into an extremely dynamic market over the past 20-25 years, with much more to offer investors than just grains produced in South-Africa.

Investors also have access to international commodities like gold, coffee, copper, cotton, soybeans and more, traded on international markets. You can even trade Instruments linked to the international commodities where currency fluctuations are removed from the equation.

Gearing

Grain investments through SAFEX make use of gearing. Gearing is the ideal opportunity to receive at least ten-fold exposure with a small investment, but it could also be your biggest nightmare if your exposure is too big and the market turns against you.

Gearing means that you earn or lose a greater percentage of your investment, compared to a direct investment in the underlying share.

Agricultural Derivatives: Futures and Options

The SAFEX on the JSE offers transparent price discovery and transactions are assured through the Derivatives clearing structure.

“We recommend that investors first familiarise themselves with the various instruments available to mitigate and effectively manage their risk,” says Becker.

Futures and options go hand-in-hand, but you don’t have to buy a futures contract in order to make money on SAFEX.

A future has unlimited high risk, but at the same time offers huge profit potential. It can however be extremely dangerous for the novice investor. Futures contracts have a future expiry date and both parties have to honour the position at the traded price on that date.

Option contracts are a great alternative to futures, but it is important that the dynamics are thoroughly understood. Option contracts give buyers the opportunity to secure a floor price (put option) or a ceiling price (call option) at the cost of an agreed premium. The sellers have to take on the opposite position if the buyer wishes to exercise their option. Buyers do not have to exercise their option.

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Proper use of futures and options in combination can be lucrative and rewarding for investors, even in a sideways market.

Grain investment strategies

Money management, a thorough understanding of instruments and the use of different investment strategies like arbitrage opportunities, split between different products, and even spreads between different months gives investors more than enough opportunity to invest very successfully just on the grain market over the long run.

There are four groups of market participants that collectively provide liquidity to the market. These participants are hedgers, speculators, arbitrageurs and investors. Participation of all four groups increase the liquidity in the market, thereby increasing the number of contracts traded and the ability of the market to act as a price-forming and risk-management mechanism.

Grain Investors

There are many types of investors on the grain market that deem the commodity market an attractive investment opportunity. They purchase futures contracts on grains such as white maize instead of the physical grain stock since they consider the futures market to be more liquid.

These traders include but are not limited to:

  • Option traders, who focus on options and make their money from option trading.
  • Spread traders, who focus on one commodity over different months.
  • Arbitrage traders, who aim to spot the differences in price that can occur when there are discrepancies in the levels of supply and demand across

Becker noted, “From a risk perspective, I would classify grain investments in the high-risk category, but only because of the gearing. If you understand futures and options in-depth, and can find a way to discipline yourself through proper money management, understand the fundamentals and have basic knowledge of technical analysis, you’ll most probably never consider other markets again.”

Who uses this type of investment?

The main users/ investors are farmers, agricultural trading houses and individual traders as well as big volume grain users such as mills or feedlots. It also includes investment companies that specialise in grain portfolio management and speculation such as us – Heimker Investing (Pty) Ltd.

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What makes the SAFEX agricultural market ideal is the fact that you do not have to be part of the supply or demand side to invest and trade on it.

Why should an investor include or consider this alternative investment in their portfolio?

Grain investments are a great way to diversify your investment portfolio. The commodity and grain markets have almost no correlation (low to negative) to the equity, bond and property markets and these, therefore, do not impact your investment in grain.

Trading on SAFEX offers various trade instruments depending on your risk appetite and trade knowledge.

Grain investment benefits

A grain investment has almost no correlation with equity markets. An equity markets crash does not mean your investment in grain would take a hammering as well. In fact, in some cases, your grain market portfolio might even increase in value while somebody else’s equity portfolio takes a beating.

With proper research and a fundamental understanding of the market, opportunities with limited downside but exceptional upside potential can arise.

Grain investment pitfalls

A limited understanding of futures and options can increase your investment risk. Gearing plays a pivotal role in grain investment, therefore in-depth knowledge, proper money management and controlled exposure is required to ensure that the required/ set results are achieved.

Conclusion

It is difficult to determine the actual size of the South African futures market as it depends on the specific future, however, the market is very liquid and futures can be bought or sold on any day.

You can trade your own account, be part of a fund, or ask a licenced individual or organisation to manage a segregated portfolio in your name.

“Grain investments on SAFEX is truly diverse and the platform offers access to trade most commodities. Every active investor/trader in South Africa should open an account on SAFEX and add it to their investment portfolio as part of their investment diversification strategy.