Chapter 1

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about SUGAR BUYING for Jobbers

_How you can lessen business risks by trading in Refined Sugar Futures_

_by_

B. W. DYER

A BOOKLET FOR JOBBERS WHO SELL SUGAR

_Lamborn & Company_ SUGAR HEADQUARTERS 132 FRONT STREET · NEW YORK

Copyright, 1921 LAMBORN & COMPANY

About Sugar Buying

Jobbers who have had considerable experience in exchange operations will find in this booklet a simplified and non-technical description of activities with which they may be in general familiar.

We believe, however, that the inauguration of trading in refined sugar futures on the New York Coffee and Sugar Exchange, Inc., throws open a new realm of opportunity.

We have attempted to outline briefly the chief advantages to be gained by a jobber's use of this new market, assuming that those who have in the past dealt in raw sugar as a protection for their refined sugar needs will welcome suggestions as to the benefits to be derived from trading directly in refined sugar.

Time, the Croupier of Business

Like a croupier at a vast roulette table, Time presides over the realm of business.

Time is the tap-root of most business uncertainties.

No one can tell what will happen a year, a month, a day, a minute from now--the future may bring floods and wars, pestilence and drouth; or it may bring great crops and fair weather, happiness and prosperity.

As business has become more and more complicated, the time element has become larger and larger. The time element as we know it does not exist in simple barter--a man weaves a piece of cloth and exchanges it for a bushel of corn: time is of no account in the transaction. A small jobber located in the same territory as refiners buys a small amount of sugar today and distributes it to his trade the next--time is negligible. A large jobber, buying perhaps for several branch houses, or located at points which necessitate a delay of two or three weeks in transit, may find it necessary even on a declining market to purchase a considerable amount of sugar, and, as a result, weeks may go by before his sugar arrives and is sold--time is vitally important.

Time is an element in costs and prices, because over any extended period of time many things may happen to influence costs and prices.

All business planning must deal with Time.

To the unenlightened business man, Time is a bugaboo--a gambler whose cards are stacked and against whom there is no defense. Such a man conducts his business from hand to mouth, in constant fear. He is a fatalist, taking his profits and losses as if they were gifts or blows of Fortune.

The enlightened man works with Time as an impartial, exacting, inevitable power for his own good or ill. He shapes his actions and enlists the services of Time to prevent catastrophe on the one hand, and to enforce prosperity and happiness on the other. Storms may come, but so far as his mind may control it, he is "the master of his fate."

Cost and Selling Prices

That the element of TIME is important in the jobber's business no one will deny. He does not base his selling price on cost, but rather on the market price. Regardless of his cost, he must sell to meet competition. It is equally obvious that the larger his business, or the greater his distance from the source of supplies, the more important part TIME plays in both his cost and selling prices.

All jobbers, large or small, are obliged to assume greater risks (even proportionately) and exercise greater care, than, for instance, retailers buying in small quantities. A jobber's business may enlarge by a perfectly natural process of expansion, but his purchasing risks increase in greater ratio than his business expands.

Similarly, under abnormal conditions, jobbers located at points requiring several weeks in transit prior to delivery, must assume greater risks than those located at the source of supply. In the event of serious delays in deliveries or in shipments, even buyers located at shipping points are confronted with this problem, and the difficulties of those located at a distance are increased immeasurably.

These difficulties tend to accentuate the importance of TIME in modern business. As business grows, instead of decreasing--risks increase. Any machinery which might operate to eliminate or reduce this uncertainty or speculative element in a jobber's business, would, we believe, be welcomed. Exchanges provide just such machinery.

Other commodities, such as raw sugar, wheat, cotton, pork and coffee have had this machinery for years and it was provided for refined sugar on May 2, 1921, when trading in refined sugar futures was inaugurated on the floor of the New York Coffee and Sugar Exchange, Inc.

Where Buyers and Sellers of Sugar Meet

The Sugar Exchange is a market place, where buyers and sellers of sugar or their representatives meet to trade.

The Exchange provides a concentration point, where, under any market conditions, sugar may be bought or sold _at a price_.

What that price is, is determined by how much sugar is for sale and how many people want it. If the supply is large and buyers are few, the price will be low. If sugar is scarce and buyers are numerous, the price will be high. Or, to put it in another way, when there are more sellers than buyers, the market declines; when more buyers than sellers, it advances. If the supply and the number of buyers are normally well balanced, the price will be determined largely by the cost of production and transportation. If events or circumstances operate to increase or curtail either the sugar supply or the number of buyers, and such events or circumstances follow one after the other alternately, the price will fluctuate.

These are the results of the operation of well-known economic laws.

In the case of all commodities which cannot be bought or sold at a common market place (or exchange), price fluctuations are usually wide and frequent, because no large group ever has common knowledge of supply, demand and other factors that govern prices--purchases and sales are made direct between individuals, and knowledge of the amount asked or paid is restricted to a limited few.

Through the common market place provided by an exchange, on the other hand, market conditions and prices become common knowledge almost instantly over the entire country. This tends toward stabilization--a fact which, alone, helps to eliminate risks, and enables merchants to buy at lower prices than if forced to deal direct with one another. Sellers do not have to take such long chances and can thus afford to sell on a smaller margin of profit. Competition is stimulated and freed from many of its complications and uncertainties to the advantage of the seller, the buyer and the public.

It is now admitted that, had exchange trading in refined sugar existed in 1920, a general use of the exchange by all branches of the trade might have prevented, to a considerable extent, the abnormal advance in sugar prices of that period, with the hardship and misfortune that attended.

The fact that an exchange always provides a buyer and a seller, _at a price_, tends toward keeping business fluid. Jobbers are able to protect their future requirements. Producers are sure of a market for their crops. Crop financing is made easier because bankers are more willing to loan on crops sold in advance--an operation made possible by an exchange.

Exchanges operate to take the gamble out of business. They help to put and maintain business on a sound basis. That some people who have no real interest in the commodity use the exchange speculatively does not alter this fact.

In providing machinery by which speculative risks incident to a jobber's business may be shifted from the jobber to those who make a business of assuming such risks, exchanges help to stabilize his business and to remove a large part of the destructive uncertainty with which he would otherwise have to contend.

Exchanges are the creations of modern economic development, designed and operated for the benefit of the commerce, industry and people of the civilized world.

Therefore we welcome trading in refined sugar futures and the opportunity to offer you the advantages that may be derived from a conservative, intelligent use of its services.

The Exchange provides certain quality standards and other regulations to safeguard your interests. But your real assurance of protection lies in the _character_ and reliability of your broker. If your broker is not strong financially you do not have back of your contract the responsibility that you might otherwise have.

If you had a favorable contract with a broker who became insolvent, you would have no means of forcing the fulfillment of the contract, and no way of securing the profit which was due you. The thing to do, of course, is to choose a broker who is so strong financially that you incur no danger in this respect whatsoever.

Use the Exchange when the Market is Favorably out of line

In considering the illustrative examples in this booklet, it should be borne in mind that the measure of protection afforded is relative and not absolute. The theory of exchange operations is that the exchange market will move relatively the same as the market for the actual commodity.

This cannot be strictly true, although the exchange market must of necessity follow very closely the actual market, because all the sugar must, in the final analysis, come from the actual market. If thrown out of parity with the actual market, the exchange market is bound to come back eventually.

In the exchange market anyone can buy and anyone can sell. The market is subject to many outside influences, and the fluctuations reflect and accentuate the varying shades of market opinions of many individuals. But in the market for the actual commodity, the quotations are made by comparatively few men, which means that there will be less fluctuation.

Therefore, it is obvious that although the exchange market _should_ be on a parity with the actual market, the unequal fluctuations of the two markets will be constantly throwing them out of parity or "out of line."

There are times when the market will be so out of line that the _buying_ of futures should result profitably. At other times, with conditions reversed, _selling_ of futures seems obviously advisable. We do not claim that jobbers can protect sugar purchases with absolute and exact precision. On the basis of long exchange experience, we _do_ believe, however, that by a discreet use of the Exchange, and by using the market when quotations are _favorably_ out of line, jobbers can do so to their decided advantage.

Selling of Futures--Hedging

As the word itself indicates, a "hedge" on the Exchange is a protection.

You hedge by buying or owning actual sugar, and "selling short" in the same amount. You sell sugar futures although you do not own any. You actually contract to deliver an amount of sugar during a specified future month at a specified price.

Eventually, you must either buy and deliver actual sugar to carry out this contract, or you must buy another contract for futures to cancel your short sale. This is known as a "covering" operation, and the cancelling of one by the other takes place automatically through the channels of the Exchange.

From the jobber's point of view, the operation of hedging has three outstanding purposes. He may hedge:

1. To eliminate the probability of speculative profit or loss, due to market fluctuations.

2. To protect a profit on a favorable purchase of actual sugar.

3. To establish and limit a loss on an unfavorable purchase of actual sugar.

HEDGING _to protect a normal jobbing profit by eliminating the probability of a speculative loss or gain_.

This operation is particularly useful to jobbers with whom conditions are such that they desire to be assured that their cost will be at about the market price at the time they dispose of their sugar, regardless of whether the market be higher or lower.

Although there are times when any jobber, no matter where located, will find this a useful transaction, it is obvious that many buyers will not wish to use the market in this way unless they feel it will decline. But it is particularly of advantage to a jobber located in markets necessitating a delay of from one day to several weeks in transit.

For instance, on a certain day in April, two jobbers bought their usual quantity of sugar. One was located in Syracuse, the other in New York. Two days following the purchase, the market broke half a cent per pound. In view of the fact that his sugars were still in transit when the market declined, the Syracuse buyer was obliged to sustain this entire loss, in order to meet competition. On the other hand, because he received and distributed the sugar before the market broke, the New York jobber was able not only to avoid a loss, but make his regular profit.

CHART 1

HEDGING to protect a normal jobbing profit by eliminating the probability of a speculative loss or gain ------------+-----------------------------------------+-----------+--------- Initial | | Transactions| Subsequent Transactions | Result ------------+-----------+---------------+-----+-------+-----------+--------- |Liquidating| Condition |Price| Result| Figure | In each | the hedge | of market | you | of | your | case |(covering) | when you |would| hedge | sugar | the | | "cover" | pay | cost | cost | same | | your hedge | in | this | this | | | |cover| way | way | | | |-ing | | | ------------+-----------+---------------+-----+-------+-----------+--------- You buy | When you | | |Profit |Actual cost| actual sugar| sell your |It has declined| | |less profit| at 6.00 | sugar (or |to 4.00 |4.00 |2.00 |6-2=4 | | when it is| | | | | | delivered)| | | | | | you buy | | | | |You get | the same | | | | |your | amount of | | | | |sugar | futures at| | | | |at the | the market| | | | |market | price, | | | | |price | whether | | | | |at the | higher or | | | | |time | lower. | | | | |when you | | | | | |sell it | | | | | |(or when At the same | | | | |Actual cost|your time you | |It has advanced| |Loss |plus loss |delivery hedge by | |to 8.00 |8.00 |2.00 |6+2=8 |is made.) selling the | | | | | | same amount | | | |No | | of futures | |It stands at | |profit,|Actual | at 6.00 | |6.00 |6.00 |no loss|cost | ------------+-----------+---------------+-----+-------+-----------+---------

Naturally the greater the amount of sugar any one concern may have in transit the greater the need for protection. We call this kind of transaction particularly to the attention of buyers having branch houses who find themselves obliged to make relatively large purchases to supply their trade in the face of a market in which they have no confidence.

These disadvantages at which out-of-town buyers are sometimes placed might be overcome by using the Exchange. On the other hand, when refiners are badly behind on deliveries, even buyers located at the source of supply will find themselves facing a similar problem the solution of which may be found in a use of the Exchange.

It is therefore evident that the selling of futures may be a transaction the _sole_ purpose of which is to eliminate speculation from a jobber's business.

Regardless of how careful a buyer may be, there is an element of _speculation in each purchase of actual sugar_.

If the price goes up, there is a speculative gain--the sugar is worth more. But if the price goes down, the buyer sustains a speculative loss.

The measure of protection afforded by the Exchange will appeal to those jobbers who wish to reduce the speculative element in their business.

In the example immediately following, as in all others, we have not taken into consideration the difference between the Exchange quotations and the Seaboard Refiners' quotations, which is explained on page 38. This would simply inject an unnecessary complication, and would be of no particular advantage for purposes of illustration.

Suppose you should buy through your broker from a refiner, for prompt shipment, an amount of _actual_ sugar at 6.00, which you plan to sell within a short time after its receipt. Instead of worrying about subsequent sugar price fluctuations, you simultaneously hedge this purchase by _selling_ futures in the same amount on the Exchange. The price at which you buy actual sugar and the price at which you sell futures should be relatively the same, since Exchange prices generally reflect refiners' prices.

You should be able to figure the cost of your sugar at about the market price at the time it is received or sold. (See Chart 1.)

If the price of sugar should go down to 4.00 at about the time when you sell it, your actual sugar, for which you contracted to pay 6.00, would be worth only 4.00; but you would then buy to cover your futures sale, making 2.00 on this transaction, which, subtracted from the price you paid (6.00), brings the cost down to the market price of 4.00. In other words, you have accomplished your purpose of being able to figure your sugar cost at the market price at the time when you received it (or at the time you sell it). That is, although every pound of actual sugar was sold at a loss, this loss was balanced by the profit from your hedge.

If, on the other hand, the market should advance to 8.00 after your original purchase and hedge at 6.00, the value of your actual sugar would be increased by 2.00. You would then buy futures at 8.00 to cover your short sale at 6.00, netting a loss thereby of 2.00. This loss would be added to your original cost of 6.00, making your actual sugar cost 8.00, which is the market price at the time. Had you omitted the hedge, your sugar would have cost you only 6.00, but, in this example we are assuming that you would sell only when you were willing to figure your sugar cost at the market price. This you have accomplished by foregoing the speculative profit you _might_ have made in favor of your normal jobbing profit.

If the market should remain relatively stable you would buy to cover your hedge at approximately the same price as you sold for, your gain or loss being practically nothing. In other words, you would obtain sugar at the market price, which is the purpose in this kind of a hedge.

HEDGING _to protect a gain on a favorable purchase of actual sugar_.

All sugar buyers have had the experience of buying actual sugar, only to see it advance or decline before they have disposed of it. How to protect the gain, or minimize the loss, is described in the two hedging positions which we now discuss.

Suppose you have bought sugar, have _not_ hedged against it, and have seen it advance. Finally you have said, "I think sugar is about as high as it is going. I am going to sell against that to protect that profit."

On the other hand, the reverse might be the case. You might find the market going down, and say, "The market is going lower. I want to hedge against that, and limit my loss to a definite amount."

CHART 2

HEDGING to protect a gain on a favorable purchase of actual sugar --------------+-----------------------------------------+----------+-------- Initial | | Transactions | Subsequent Transactions | Result --------------+--------+----------+---------+-----------+----------+-------- | Hedge |Condition |Price you| Result of | Figure | In | |of market | pay for | hedge and | actual | each | | when you | futures | covering | sugar | case | | "cover" | to cover| operation | cost | the | |your hedge| hedge | | this way | same --------------+--------+----------+---------+-----------+----------+--------- You buy actual| | | | |Price paid| sugar at 6.00,| | | | |for actual| but before you| |It has | | |sugar less|Your have received | |declined | | |hedging |sugar it (or before | |to | |A profit |profit |cost you sell it) | |6.00 | 6.00 |of 2.00 |6-2=4.00 |is the price | | | | | |2.00 advances to | | | | | |under 8.00 | | | | |Price paid|the | | | | |for actual|market You now have |You sell|It has | | |sugar plus| your sugar at |futures |advanced | | |hedging | 2.00 under the|at |to | |A loss |loss | market |8.00 |10.00 | 10.00 |of 2.00 |6+2=8.00 | | | | | | | You feel that | |It stands | |No profit, | | the market may| |at 8.00 | 8.00 |no loss | 6.00 | recede and | | | | | | eliminate | | | | | | this gain, | | | | | | so-- | | | | | | --------------+--------+----------+---------+-----------+----------+--------

In both of these cases, the operation is relative. If a man has a profit, let us say 2¢ a pound, and he hedges, he maintains his profit of 2¢ a pound as compared with the market at the time of delivery, or at the time when he expects to sell this sugar, regardless of whether the market is higher or lower.

In the same way, conversely, if he has a loss on his sugar of 2¢ a pound, by hedging he can limit that loss to 2¢ a pound, even though the market goes still lower. In other words, his sugar cost at the time of delivery, or at the time when he expects to sell the sugar, will be about 2¢ above the market price, whether the market is higher or lower.