True farmers never sell a rally

Magnifying GlassMichael Swanson, Ph.D., Wells Fargo Chief Agricultural Economist

One topic that never gets old for producers and processors is price volatility. Where does price volatility come from, and who is responsible? What constitutes price volatility?

Price volatility brings to mind the infamous quote of Supreme Court Justice Potter Stewart used in 1964 of “I know it when I see it”. You would think that everyone would agree on what constitutes price volatility − it’s when prices change.

However, no one seems to agree on how much prices need to change to equal price volatility. Most people would agree that a penny-a-bushel change doesn’t represent price volatility, so, just how much do prices need to change to equal “volatility”?

For many producers and processors, it isn’t whether the prices changed, but how fast the prices changed. Should price volatility be measured in dollars, or by percentage change? And, what time horizon matters for price volatility? If there is no hard and fast definition of price volatility, then a statement like “volatility creates marketing opportunity” becomes meaningless.

The old saying that prices go up the steps, but come down the elevator seems to fit this year’s price rally and collapse. The following pictures from the Chicago Mercantile Exchange’s website show the weekly price ranges and the ending price for November 2016 soybeans and December 2016 corn. Soybeans started their rally in March when Brazil’s crop looked to be oversold and underperforming. Corn’s very brief rally started slightly later when La Niña weather concerns seemed worth discussing. Both peaked by the middle of June just as producers were starting to become enthusiastic about selling. When prices dropped, too many producers became stubborn about the elevator ride down from the peak, and refused to sell until they were sure the elevator was in the basement. Soybeans are off $2 a bushel from their peak, and corn is off $1 from its peak in mid-June, leaving producers below their expected break-evens.

 

ZSX 2016 W Soy Bean
 
ZCZ 2016 W Corn Futures

 

One of the questions that I always get is whether farmers took advantage of the price rally to lock in additional sales. While there are always exceptions to the rule, farmers honestly didn’t take any real advantage to sell the rally. Let’s look at last year to see how farmers managed their sales against that rally. According to the USDA NASS database, the 2015 annual price of corn received in Minnesota was $3.40/bushel. This matches the University of Minnesota FINBIN database of 2,400 producers showing that the average price of corn received was $3.49/bushel. Looking at the earlier corn chart, 2015 reflected a similar rally to this year’s rally. December 2015 corn rallied to $4.20/bushel for approximately 5 weeks starting in March. During these five weeks, farmers could have sold some heavier percentage of their expected production to lock in a higher price, but most didn’t manage to sell more during this spring rally.

The 2015 December corn contract averaged $3.92/bushel during 2015, and Minnesota had a negative basis of $0.37 a bushel for 2015 according to the USDA’s AMS database. This implies that Minnesota farmers could have averaged $3.55 corn by selling incrementally throughout the year, and that actually understates how badly they performed given the stronger cash prices that started out the year. They should have been selling 2014 crop that was already in the bin. Or, farmers could have sold the 2014 production ahead of time for an even higher price. As a group, Minnesota farmers managed to sell for less than the average of the Chicago Mercantile Exchange and cash basis. It seems likely they managed to wait for a lower price in the second half of the year to sell more of their production. Well, the Minnesota producer isn’t any different than rest of the United States.

Producers don’t take advantage of price rallies in the futures market to sell their future production at above-average prices. It is just as likely that processors and buyers don’t take advantage of price drops to buy their future needs at below-average prices. So, are producers justified in their perpetual complaint that the futures market just increases volatility without providing any real benefit? They have already identified the “the speculator” as the source of their grief. Producers believe that “speculators” create the price volatility, or at least increase the price volatility.

Changing crop conditions and demand from domestic and export markets occur on a 24/7 basis, and the futures market allows these changes to be imperfectly reflected on a daily basis. This creates the daily price change that producers and processors call price volatility. But, the price changes would occur anyways without the futures market and its daily battle of the bears and the bulls, however, the price changes would probably occur in fewer, but larger price shocks.