Surprised that the market was surprised

CropsMichael Swanson, Ph.D., Wells Fargo Chief Agricultural Economist

The most recent USDA World Agriculture Supply and Demand Estimates (WASDE) report surprised the market because it was closer to normal yields than the analysts expected. Why the surprise? The following graph shows that the percentage of the crop that was rated “good” or “excellent” was never more than 3% below the 30-year average. Likewise, the percent of the crop rated “poor” or “very poor” was never really higher than the 30-year average. It would be hard to argue that the statistics ever justified the expectation of a significantly below-average yield. So why did the analysts get so bearish on yield?

Corn Crop Rating 2017

It is a good example of emphatic story-telling overwhelming the larger picture. To start off, farmers planted 180 million acres of corn and soybeans. That’s about 281,000 square miles of corn and soybeans across more than 18 states. It simply is not possible for anyone to truly picture that amount of acreage. For a little exercise, take a walk around a section which is one square mile. Most people, walking hard, average four miles per hour, so in an hour, you would cover just one section. This starts to give us a little appreciation of the scale of farming in the U.S.

The challenge is maintaining this perspective when you hear stories about fields that were planted too late, or were too dry to produce a crop. It’s easy to share pictures of terrible fields or great looking fields. We start to think that we know something about the nature of the national crop. In fact, we are fooling ourselves with the tails of the distribution. It basically takes a drought across the “I states” to substantially change the national yield. And, there was no drought in 2017 in the key growing states. So it should not be a surprise that we have an average-type crop.

As we closed out the last week of August, the market continued to find new lows for the corn and soybean crop. Abstracting away from all the daily noise, it is a very bearish, long-term signal that a slightly subpar yield for corn and a normal yield for soybeans can suppress prices. The 2017 crop year and price development continues to reinforce the view that global supply and demand growth will remain balanced with $3.50 corn and $9 soybeans.

US National Cash Corn Price per Brushel

So, can the American farmer make money and continue to invest in land and equipment with $3.50 corn and $9 soybeans? They will absolutely continue to make those investments, but they will demand that the land and equipment be priced to make a decent return based on these prices. Over the last 6 years, return on assets for crop production has averaged slightly more than 5% according to USDA statistics. This return on assets is about 30% lower than other sectors such as manufacturing and financial services. Farmers and investors are willing to take a lower return on farming assets for the diversification and the reliability of demand, but they won’t ignore other returns entirely. As lower crop prices cap returns, the cooling process for land values should continue for the next couple of years.