In a few short months, the ground will thaw and planting will begin. Along with the change in season will come an abundance of market opinions (mostly bullish) about where prices are headed this year. Before you get swept away with all the different analyses, there are six things about grain prices that you should keep in mind every year.
One: Farming is one of the most competitive business environments that you will ever find. There are thousands of producers of various sizes, none of which has any clout when it comes to haggling prices. The grain producer is the prime example of a "price-taker" and that fact alone tells us that over the long haul, grain prices will spend most of their time near or below the costs of production.
Two: Thanks to human nature, the price cycle for grains is strongly asymmetrical, meaning that prices spend far more time in downtrends than they do in uptrends. When prices are good, producers are eager to expand production and the whole ag industry is eager to help them. The rush to produce more is what kills an uptrend. On the other hand, when prices are bad, there is no hurry to cut production. Nobody wants to fire workers or auction off equipment until they absolutely have to. Without a government program, there is no incentive to cut back acres. It takes much longer to bring about the behavior that ends a downtrend.
Three: Like it or not, subsidies that are above the cost of production encourage more production, larger grain stockpiles, and longer downtrends. As a good example, look at the cocoa market. Cocoa prices have been in a downtrend for 24 years, thanks largely to the subsidy policies of the Ivory Coast. You should also notice that governments are most likely to abandon those subsidies when prices are at their worst. It's easy to get political support for subsidies when the cost is small. It's another matter, when grain prices are in the tank and the cost of those subsidies becomes expensive.
Four: Traditional economic theory relies on the consumer taking advantage of low prices to bring balance to the market. However, low prices, in and of themselves, do not stimulate enough consumption to balance market forces. Show me a market with low prices and a bearish outlook and I will show you consumers that are in no hurry to buy. Why should they be in any rush when they are expecting abundant supplies later? Let the other guy pay for storage. Bullish market outlooks and a fear of tight supplies are what stimulate market buying; not low prices.
Five: Producers want to hear bullish market outlooks early in the year and there will never be a shortage of advisories that are willing to provide them. It is only human to want to hear good news. Unfortunately, bullish outlooks early in the year discourage producers from hedging their risks when the costs of doing so are advantageous.
Six: When it comes to predicting the future, there are no experts. War, weather, disease, government policies, and international crises all have huge, unpredictable influences on market prices. It doesn't matter who you are or how much you think that you know, the market will always be a source of surprise to its participants. It is not wise to leave yourself vulnerable to anyone's prediction.
Soon you will be hearing about how this will be the year that soybeans hit $7.00 and corn goes to $3.50. Who knows? Maybe this will be that one year when farming really pays. But just in case it's not, it would be wise to look at your options, consider the six things above that are true for grain prices every year, and protect yourself from the risk of lower prices.
Dailyfutures.com. February 12, 2002.
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