Diamonds are Forever

1. GERKENS Cacao Diamonds are Forever

2. GERKENS Cacao About hedging Price Risk of Goods. J.A.C. Rietveld 28th June 2007

3. How to hedge? GERKENS Cacao A Future Market could give you the solution!! There, you can buy and sell “futures” contracts. A futures contract is a: “financial product through which a buyer and seller undertake to exchange a particular quantity of a commodity or financial instruments at an agreed price on a stipulated future date”.

4. How to hedge? GERKENS Cacao The good thing about these contracts is that youdon’t need to deliverphysicalsimmediately. The Future contracts are based on a standard quality and a standard quantity The other good thing is that these contracts have a unique counterpart, the clearing house.So when you had sold some contracts, if you don’t want to deliver the goods, you just have to buy other contractsand the clearing house willcancel/washthem out.

5. Exchange Contracts made here Order Order Seller Buyer Contract Clearing House Paper Trade Flow GERKENS Cacao Contract

6. GERKENS Cacao HEDGING 1.What is a future market and how does it work 2.What do you need for a good and smooth working future market. 3.How to manage RISK of volatile markets by hedging.

7. GERKENS Cacao HEDGING 1.What is a future market and how does it work A future market is like a stock market 1. You can buy and sell in the future 2. You can hedge your risk of physical business 3. A future market reflects the underlying, physical world market on which you can deliver and on which you can take delivery 4.A future market reflects the supply/demand situation of the underlying, physical world market

8. HEDGING GERKENS Cacao 2.What do you need for a good and smooth working future market. a) A standard contract, with a standard quantity and quality b) Enough participants (players), hedgers , investors and speculators to secure liquidity c) An exchange where buyers and sellers find each other, screen trading or open out cry, could be with an existing exchange

9. HEDGING Do you like risks? GERKENS Cacao 3.How to manage RISK of volatile markets by hedging. Is trading DIAMONDS a RISKY business Either you like risks: you SPECULATE. Or you don’t like risks: you want to HEDGE.

10. Trading GERKENS Cacao • Hedging, the futures market • Differential • Speculators A lot of similarities between the Pricing of Diamonds and Cocoa. A kind of basis products with a basis world price and a lots of different products, quality differences, with a price difference to the basis market price A DIFFERENTIAL Here after the presentation will be about COCOA FOR YOU PLEASE READ DIAMONDS FOR COCOA

11. Buy Sell x x Buy x x Sell Price fluctuations. GERKENS Cacao Price per ton $ 1500 $ 500 Time CASE 2 CASE 1 Because of strong price fluctuations, trading cocoa beans is a RISKY business.

12. GERKENS Cacao Hedging The futures market

13. How to hedge? GERKENS Cacao The best hedge against price fluctuations would be to NEVER keep positions… As soon as you BUY cocoa, you SELL it immediately. And as soon as you SELL cocoa, you BUY it immediately. But this may be difficult since good buyers and good sellers of cocoa stocks are not easy to findat the exact same time.

14. Whenever you buy a quantity of beans (physical), Whenever you buy a quantity of beans (physical), Whenever you sell a quantity of beans (physical), Whenever you sell a quantity of beans (physical), Buy / Sell Buy x you sell the same quantity on the New-York or London market for a later delivery (paper contract). you buy back the same quantity on the New-York or London market (paper contract). $ 500 x Sell / Buy Sell Cocoa sale New-York Price hedging. GERKENS Cacao Price per ton $ 1500 Time The money you LOOSEwith the physical cocoa is compensated by the money you GAINwith the “paper” cocoa.

15. Cocoa sale New-York Price hedging when prices go up. Price per ton $ 1500 Sell / Buy x $ 500 x Buy / Sell Time The money you GAINwith the physical cocoa is compensated by the money you LOOSEwith the “paper” cocoa.

16. Price hedging. GERKENS Cacao Whether prices go up or go down,the physical cocoa price risk (gain/loss) will be compensatedby the “paper” cocoa price risk (loss/gain).

17. GERKENS Cacao Differentials

18. Cocoa sale - New-York Ivory Coast Differential. GERKENS Cacao The hedge by using New York or London markets is not perfect because the price of the physical cocoa is rarely equal to the price of the “paper” cocoa. The difference is called DIFFERENTIAL. = DIFFERENTIAL

19. Cocoa sale - New-York Ivory Coast Differential. GERKENS Cacao Indeed, contracts in New-York and Londonare STANDARDIZED and cannot reflectthe full reality of physical bean stocks. The DIFFERENTIAL depends on: - the quality of the bean (origin, bean size, defects…) - the supply and demand of this origin and quality - the location and format of the stock = DIFFERENTIAL

20. A trader seeksthe differential price riskand hedge himself fromLondon or New-Yorkprice change risk. A speculator seeksthe London or New-Yorkprice change risk. Managing risks. GERKENS Cacao Physical London bean price (reference) Differential Buy: £1545 £1500 £45 = + Sell: £565 £500 £65 Balance: £-980£-1000£+20

21. Speculators GERKENS Cacao Very much needed they bring liquidity into a market • “Speculators” or “Hedge Funds” frequently enter the market • There are several kinds: • Those that trade on fundamental information • Those that trade on technical analysis: “reading the charts” • Pension funds that invest in commodities

22. Speculators GERKENS Cacao • They have so much money, they can push markets in a certain direction. • This can create opportunities if it is against the fundamentals • The last 2 big price moves in the last 2 years were caused by hedge funds buying the market and then selling it off again

23. GERKENS Cacao END