How Merchants Secure Protection by Hedging

The cotton merchant, in making a hedge, would proceed in this fashion.

Having made an actual sale of cotton to a spinner for future delivery, the price being fixed according to current quotations in New York for deliveries to be made in the month specified in the contract, he would buy futures for a corresponding amount of cotton on the New York Cotton Exchange.

If the price of cotton should have advanced when the time for the delivery of the actual cotton comes, he will be able to sell his futures contract at a higher price, thus offsetting the loss sustained upon the deal in actual cotton. Or, if he prefers, he may hold the "futures"

contract until its maturity and sell it at the then prevailing figure.

The first course would be the customary one for a bona-fide merchant, whose sole concern is protecting himself against loss by fluctuations in price.

If, on the other hand, cotton should fall before the merchant bought to fulfill his actual contract, he would make a profit upon his sales to the spinner. He would, however, suffer a loss upon his futures contract, for the seller would be able to purchase the cotton to fulfill the contract at a lower point than the contract called for, and would consequently be able to deliver to the merchant who made the hedge, cotton which the latter would be forced to accept at a price higher than the then prevailing one, and thus again the profit and loss would balance each other. The usual custom is, not for the merchant to accept delivery, but to pay over to the seller of the futures contract the difference between the contract price and that prevailing. This would be just the difference between his own purchasing and selling price in his actual dealing with the spinner, and so would eliminate the profit, due to change in price, made in that transaction. Thus, by the hedging process, the merchant loses a possible profit on a falling market, but at the same time fails to suffer a loss when the market is against him.

Hedging as Practiced By Cotton Manufacturers

The manufacturer's hedging is necessarily somewhat different in practice, though the same in principle. If he accepts orders for cloth requiring more cotton than is being held in his warehouse, he may buy futures contracts to the amount of the additional cotton he will need. Then in the event that his actual purchase of cotton may be at a figure which would tend to reduce or eliminate his profits on the sale of the cloth, already fixed by contract, he may sell his futures contract at a corresponding profit, thereby preventing loss. Should the price of cotton fall in the interim, his profit on the sale of the cloth will be larger, but the settlement of his futures contract will be expensive to the same extent. Thus he sacrifices the chance of a greater possible profit in order to be insured against loss.

[Ill.u.s.tration: _Compress bales bound for New Orleans_]

It is probably more common for the cotton merchant to hedge than for the manufacturer to adopt that proceeding. The manufacturer, as a rule, has been accustomed to buy his cotton during the buying season, that is, in October, November, December, and January, and he makes his arrangements with his selling agents on the basis of the price paid, trusting to his own judgment, and the comparatively small fluctuations in the price of cloth in normal times, to protect him against loss. It is usually believed that the Southern mills, being newer, and frequently of a different financial standing, have found it more desirable to have recourse to this form of insurance than their older compet.i.tors in the North. Then, too, the rapid development of the cotton warehousing system has made it less necessary for the manufacturers to tie their money up in great quant.i.ties of cotton, as they can buy when the market appears favorable.

Protection for Mills Running for Stock

A very important point, however, and one which all manufacturers would do well to consider carefully is the protection which a "futures" market gives to a manufacturer making plain goods for stock, particularly on a falling raw material market, which, of course, would also mean a falling goods market. To stop the mill because values were falling would be impossible without utter disorganization, and its attendant heavy loss, while to keep on manufacturing stock goods with a certainty that they would be worth less each succeeding month is a disheartening prospect for the mill.

If, however, the manufacturer sells "futures" for the succeeding months to the extent of the cotton which he would require each month to manufacture the goods, he can run his machinery as usual and have a perfectly free mind, as he has safeguarded himself against any loss due to a falling value of the raw material. Suppose, for instance, the cotton market fell off, say one cent a pound each month, with a corresponding fall in the value of the woven goods. In such an event, the manufacturer could, as each month arrived, buy a contract for an amount corresponding to what he had sold, and at a proportionately less price, thus making a profit on the "futures" which he had sold to an extent which would correspond, approximately, to the smaller value which his manufactured goods would then have in the market. Thus the profit on the one side would take care of the loss on the other. If the market rose instead of falling, he would make a loss in replacing his futures contract, but his goods would then command a higher value, and again no loss would be experienced.

This method of hedging is the regular and standard practice of the English cotton mills, and, of course, of many of our domestic mills, but there are some manufacturers who, through their unfamiliarity with the operations of the futures market, are quite unaware of the protection which they thus have at hand.

The Responsiveness of the Great Exchanges

The great exchanges, and the New York Exchange in particular, are thus used by cotton merchants and manufacturers in every part of the world to protect themselves in their buying and selling operations. The value of middling cotton in New York is kept upon par with the value of the same cotton in any growing or manufacturing point, such factors as freight, insurance, brokerage, etc., being allowed for in the quoted price.

Quotations on the Liverpool Exchange are thus higher than quotations in New York by the difference between the amount it costs to deliver cotton in Liverpool and to deliver it in New York. Thus the merchant and manufacturer is able to buy and sell hedge contracts on the New York Exchange, knowing that operations at the New York price in New York are on a parity with operations at the Liverpool price in Liverpool, or at the Havre price in Havre. Thus the hedge contract which a Southern merchant sells in Atlanta, through his broker on the New York Exchange, may be bought by a spinner in Tokyo or Manchester, anxious to insure his supply of cotton at a price which would make his contracts profitable.

In normal times the selling of merchants and the buying of manufacturing engaged in actual and bona fide hedging transaction has been estimated by competent authorities to make up fully seventy-five per cent. of the trading done on the New York Exchange. The remaining twenty-five per cent. may thus be attributed to speculative operations, that is operations entered into by outsiders through brokers, on the chance of a rise or a fall in the market. Nor is such speculation without its value.

It is the speculators, as a rule, who are the first to take advantage of crop reports or weather conditions, or news likely to affect the market favorably or unfavorably, and buy or sell as their judgment dictates.

Their operations serve to discount such changes to some extent, or at least to make the breaks and rises more gradual than they would otherwise be.

In abnormal times, that is times of great scarcity and great demand, or b.u.mper crops and small demand, the speculative element plays a larger part, for it is in such times that the greatest fluctuations in price take place. Merchants or manufacturers holding hedging contracts are under a greater incentive to buy or sell, as they see their opportunities for profit growing greater or less, as the case may be, and in consequence more contracts are made, and they pa.s.s from hand to hand with greater rapidity, the gain or loss thus being distributed among a greater number of persons than would otherwise be the case. It is the operations of speculators, and the manipulation that once or twice during its history has been possible by unscrupulous traders which has brought about at such times public agitation for the abolition of the Exchange. Recent changes in the form of the cotton contract have made it almost impossible for such operations, if repeated, to be successful, and thus there is little likelihood that the very important economic function of the Exchange will be interfered with by legislation.

CHAPTER IV

The Cloth Market

The output of the manufacturer finds its way to the ultimate consumer through a variety of channels. What these are will depend upon the manner in which the various mills are organized, and their respective policies as to the marketing of their products. Some mills, usually very large organizations, will have plants completely equipped, in every department, spinning, weaving, dyeing, printing, finishing, etc., and will process all of their goods themselves in every detail, offering them on the market in their finished form. Some of these may make a wide variety of fabrics suitable for one cla.s.s of trade, or for many cla.s.ses of trade, while others will specialize on a few articles. A good many concerns that are not of the largest size, but which confine their production to a few articles, may also put the goods through every operation themselves.

Then there are a great number of cotton mills, many of them of very large size, which do no weaving at all, but confine themselves to spinning, finding a market for their yarns with the many weaving mills which have no spinning plants.

Many Large Mills Do No Finishing

Numerous mills, both large and small, manufacturing, princ.i.p.ally, goods of a staple grade, which may either be of fine or coa.r.s.e character, sell their entire product in the gray, or unfinished state, because they do not wish to burden themselves with the task of putting the goods through the various finishing treatments necessary to fit them for the market.

This method of disposing of the product appeals to many for it reduces the manufacturing operations to the spinning of the yarn, and to the weaving of the cloth. The owners or managers of the mills may have had no experience outside of these branches, and if they themselves were to attempt to finish, or "convert," the goods they would be entering strange fields.

Whatever method of merchandising may be adopted, it is certainly obvious that the product of large mills is so great that it must be disposed of in a large way, and hence various channels of outlet have grown up to satisfy the requirements of the case.

Dealing Direct With Dry Goods Jobbers

A substantial portion of the output of the mills (but nothing like what it was years ago, and it grows relatively smaller every year), is disposed of directly to dry goods jobbing houses, and by them to retail dealers, who sell it by the yard to the consumer. This practice was formerly more widespread, but has diminished greatly in recent years. A further enormous yardage pa.s.ses eventually through the cutting-up houses, which manufacture garments of every kind, from overalls to pajamas, or from raincoats to shirts, and dispose of their products to distributors, who eventually sell them to the public. Then there are retailers whose requirements for goods of particular kinds are so considerable that their orders are of sufficient magnitude to warrant the mills in dealing with them direct.

Again, there are the great mail-order houses, with a gigantic annual turnover, whose catalogues go to every part of the land, and which handle great quant.i.ties of piece goods, as well as made-up garments, and whose custom is eagerly sought for.

[Ill.u.s.tration: _Thousands of looms in a single room_]

Other mills make fabrics suitable for use in the military and naval establishments of the country, and in other public channels, and which, in selling these fabrics, will deal directly with the Government, or indirectly through intermediaries.

In addition to these, and other domestic outlets, there is a great quant.i.ty of goods produced for export, which are handled through houses specially organized for that trade.

Merchandising by Dry Goods Jobber

One of the oldest established agencies for handling mill products is the dry goods jobber, and it is to be remarked that many large retail houses do also a substantial jobbing business, though generally less so in cottons than in other cla.s.ses of fabrics. The jobber will buy finished products from those mills which sell goods in that state, and will also buy large amounts of gray goods. These he will sell princ.i.p.ally to retail distributors, but his transactions, in addition, will extend into a mult.i.tude of channels, and, he will deal with small garment manufacturers and makers of all kinds of wares, and will also sell considerable quant.i.ties to the larger cutters when they are unable, for one reason or another, to buy direct from the mills or from the converters. There are also numerous small jobbing concerns which buy substantial quant.i.ties from the larger jobbers as occasion may require.

One of the greatest avenues of outlet is through a cla.s.s of dealers known as converters, and there are converters operating in every kind of fabric from cotton to silk. In the last forty or fifty years, this business has developed into immense proportions, and the converter performs a real and important service in the trade. He is intimately acquainted with the needs of his customers, and possesses a fair knowledge of the kinds of goods put out by the various mills and the different constructions in which they are sold, and is well acquainted with all of the market dyeing, finishing, bleaching, and printing concerns, having also a fair understanding of the various treatments accorded to the goods. He buys his goods in the gray from the mills, and sends them to the finishers, printers, etc., to be treated, according to his instructions. By a careful studying of the fabric constructions, and of the subsequent treatments, he is able to create fabrics of a suitable and marketable character, which are in some respects different from those offered by any of his compet.i.tors, and which are brought out with an exact knowledge of the requirements of the trade to which he is catering. He is able to make a profit, and generally a very substantial one, by handling the goods in this way.

Considerable capital is required by the converter, as goods bought in the gray have to be paid for on practically a cash basis, and he may have to carry them for a time before they are finally marketed. The converter sells to the cutting-up houses, to jobbers, and to retailers, or, in fact, to whatever trade he seeks. Large and profitable businesses have thus been built up. Many converters have adopted their own distinctive trade marks, and since the goods that they handle are known by these trade marks, the ident.i.ty of the mill which made them originally is often entirely unknown to the ultimate consumer. The converter can give his business to whatever mill, at the time, will give him the best value for his money.

Jobbers Must Know Status of Mills

These operations are facilitated by the services of another cla.s.s of intermediaries, the cloth brokers. If a buyer, whether he be retailer, jobber, converter, or what not, wishes to secure goods of a certain kind, he would have a very difficult task if he had to canva.s.s the entire market, and ascertain what was being offered. Hence he is likely to go to the cloth brokers. They are in touch with all the princ.i.p.al manufacturing sources of supply, and will have daily quotations of the offerings of the different mills; he will know which mills are "sold up," and which are open for business, and what cla.s.s of goods they desire to sell.

Consequently the cloth brokers are in a position to offer to would-be purchasers a wide variety of the different cloths which are available on the market, and it is their business to buy from the mills as cheaply as they can, and so get the best possible price for their customers. The transactions are handled on a small commission, and the average buyer, in many kinds of goods, is able to do much better by working through a broker than by opening negotiations directly with the mill.

Most Mills Have Offices in Chief Markets

Mills selling their products through brokers in this manner may, or may not, have a representative stationed in the goods market, according to circ.u.mstances. Mills, manufacturing a limited number of plain fabrics, and which do not sell through brokers, may also be without representatives in the primary goods market, and will dispose of their product directly from the mills, partly by correspondence, and partly through the efforts of their travelers. The great ma.s.s of the mills, however, are regularly and efficiently represented in the great central goods markets, princ.i.p.ally New York, though also in Boston, Philadelphia, Baltimore, and elsewhere, and their selling agencies are very highly organized inst.i.tutions.

These establishments which have sufficient capital to enable them to finance themselves--with or without the a.s.sistance of regular bankers'

loans--may maintain their own selling offices, and market their product in their own names directly to their customers. The amount of capital required to handle a business in this way is proportionately very large, for the concern must be able to keep itself sufficiently supplied with raw materials, and then to carry the expenses as these materials pa.s.s through the slow stages of manufacture until the goods are finally finished, after which they may have to be kept in stock for a time until the delivery dates, and then, after shipment, the accounts have to be carried until the bills are paid, so that, from the time the manufacturer pays for his raw material until he finally receives pay for his goods is a very long period.

Loans Made Upon Warehouse Receipts