farmgate: Grain Market Volatility: How Does One Survive?
The past two years when corn and soybean prices were higher, the volatility was not always appreciated. This year, after the volatility has disappeared and prices have found a sideways trend, they are still not appreciated. Current grain price trends, which have become the Rodney Dangerfield of the farm economy, are just not respected, but is that because they are not well understood?
Common questions revolve around the permanency of high prices, the tendency for volatility, and the impact on farmers, grain merchandisers, and end users. That is the perspective of agricultural economists Scott Irwin and Darrel Good at the University of Illinois, whose analysis is included in the current issue of the electronic magazine Choices.
Irwin and Good look back 35 years ago to the early 1970’s when the grain market last climbed to a new level, and compared that to the recent upward market trend. That period of volatility and a new price level was the function of exchange rates, Soviet grain purchases, higher energy prices, and rapid inflation. They believe, “As a starting point, if average monthly nominal prices in the new era that appears to have begun in late 2006 increase by a similar amount to those over the post-1972 period, averages would project to about $4.60 for corn, $5.80 for wheat, and $14.40 for soybeans.” That would put the corn/wheat ratio at 1.26 and a corn/bean ratio at 3.13, which they contend is too much for crop competition.
Since the shift to a higher price level, as seen in the late 1940’s, the early 1970’s, and the current period has been marked by volatility, the economists looked at how the range of volatility compared to prices when they finally settled down.
1) Low prices were 66 to 77% of the average price for corn.
2) High prices were 146 to 201% of the average price of corn.
3) Low prices were 71 to 81% of the average price of beans.
4) High prices were 161 to 166% of the average price of beans.
5) Low prices were 57 to 96% of the average price of wheat.
6) High prices were 162 to 175% of the average price of wheat.
Applying those average to today’s prices, the economists say, “To date, then, the average monthly price of corn and soybeans has been lower than projected for the new era. The average price of wheat has been near the projected average for the period.” But are those projections taking into account current market fundamentals? Irwin and Good say corn is being driven by the ethanol/crude oil market, “Not only do ethanol prices explain about 90% of the variation in corn prices, but the relationship is evident over the entire wide range of ethanol prices during the last couple of years.” They go on to say the simplest way to think about corn prices is the value of corn to an ethanol producer, and a rise in crude oil would shift both ethanol and corn to higher values, with wheat and beans having to climb as well to remain competitive for acreage.
What does that mean for the farmer? They say it means (1) that a shift to higher price levels has occurred, (2) peak prices have been well above projected prices, and (3) prices can still move lower. It also means average prices will impact the producer in the form of farm income levels, profitability, and value of land. The variations in prices from year to year also underscore the importance of using options contracts to protect profitable prices, while reducing chances for the use of forward cash contracts because of limitations imposed by cash grain buyers. Finally, they believe that such price levels will also have an impact on participation in government farm programs, including both revenue support programs and crop insurance programs.
What does that mean for the grain elevator? They say the higher potential prices mean the need for more cash to buy grain, and the magnitude of volatility will determine the amount of capital needed for margining hedged grain, and having good access to credit markets. It also means a potential for risk that grain sale contracts will not be fulfilled, if producers can obtain higher prices elsewhere.
What does that mean for end users? The end user is concerned about acquiring the cash grain commodity and the timing of the delivery. That means end users have to maintain profitability all the way from contracting for grain to be delivered through the pricing of the end product made from the grain. In the event they are unable to do that, they will have to rely on the spot market for both inputs and outputs, increasing their risk.
Summary:
Grain prices have undoubtedly taken a turn upward with a healthy dose of volatility. But market observers will also compare it to prior times, and say, “been there, done that.” The challenge is for market participants to understand the potential range of volatility in the market and be able to price both sales and purchases of grain at levels of manageable risk.
Posted by Stu Ellis on April 23, 2009 12:17 AM to farmgate