farmgate: What Did We Learn From The Markets In 2008?
The staff and management of the farm gate extend our best wishes to you for a Merry Christmas and a profitable New Year. And being the educational folks that we are, our Christmas Day gift to you is a collection of marketing lessons, which we all learned in the past year.
Even the best of marketers had a challenging year in 2008, watching the market climb to record levels, then fall precipitously because of outside markets. Marketers who depend on reading the fundamentals threw their arms up in disbelief. But looking back over the past year, Melvin Brees at Missouri’s Food and Agriculture Policy Research Institute offers several lessons that we can apply to future challenges.
1) It is a big world out there. The typical fundamentals of supply and demand will not always define the market price. Brees says worldwide financial conditions, international supply and demand forces, currency values, politics and other factors push and pull on the price of grain. There are probably thousands of different global dynamics that impact the price of US corn and soybeans. Brees says add those to the list of domestic fundamentals, such as the ethanol demand for corn and corn acreage that has caught the attention of large commodity trading funds which have been blamed for using techniques that distort the market. All of these and many more have inserted a new level of price volatility into the market that means large price risks for producers.
2) Price opportunities do not last. We have to re-learn that hard lesson every time prices reach new highs, as they did in early summer of 2008. Brees says the steep uptrend that began in the fall of 2007 became a steep downtrend in mid summer 2008. He says history shows that record prices never last very long and those who waited for more always missed out. Brees says a marketing plan should always include a strategy for capturing prices during a market rally.
3) There is risk in depending upon cash contracts. The spring of 2008 brought higher prices and many farmers booked forward contracts at elevators, which were then obligated to hedge the purchased grain on the Chicago Board of Trade. But with the market moving against that hedge, elevators at every railroad junction were forced to pay margin money to the CBOT or close out the hedge. Subsequently many elevators halted the use of forward contracts, the primary risk management tool of the Cornbelt farmer. But other farmers who contracted delivery to some ethanol plants that have failed, are now obligated to deliver at prices well below the contract. The use of futures and options are expensive risk management tools, but will allow producers to remain in control of their marketing.
4) Risk management has become expensive. As noted previously, the maintenance of a futures or options account will be an expensive risk management tool. The volatile market required a $2,000 margin account per corn contract and $4,000 per soybean contract. But the rising market demanded another $3-4 per bushel be added to the corn margin and another $8 per bushel for soybeans hedged. Options were less expensive, if you consider 60-70¢ per bushel for corn and $1 per bushel for soybeans to be less expensive. All of these strategies provided price risk management to the producer, but it is a lesson that has to be mastered by the producer and the lender.
5) Marketing risks that became apparent in 2008 need to be considered in 2009 business planning. Market volatility threatens farmers’ ability to capture profitable prices, and price risk management will be an important element to maintaining profitability in 2009. Just as production inputs have increased in their expense, so has the cost of risk management, which farmers and their lenders will have to understand. Unfortunately, it has grown more complex.
Summary:
Commodity prices in 2008 were significantly influenced by non-traditional supply and demand factors, which could resurface in the future. Farmers saw fast rising and falling markets, and along with the fall they learned that price opportunities do not last very long. The farmer-friendly forward contract created financial havoc for grain elevators, which quit offering them due to unforeseen costs, demonstrating that there is a significant cost to good risk management practices. Future risk management will be expensive, but a necessary part of a farming operation that needs to be understood by farmers and lenders.
Posted by Stu Ellis on December 25, 2008 12:48 AM to farmgate