Well, farmers, you’re facing the ultimate year for crop marketing and hedging in front of you!
If you do it right, you could be tens or hundreds of thousands of dollars ahead of where you’d be if you did it wrong.
If you do it wrong, well, that’ll really suck.
Now, how to do it right. That’s the rub.
But before I let my fluffy little brain think about that, I want to think about mortgage rates for a moment.
Yes, I know, they have little to do with ag, but what’s going on with residential mortgage rates helps highlight a hedging risk that farmers face this year.
Yesterday Bank of Montreal cut five year mortgages to under-three percent, which drew a waggy finger from the federal finance minister, concerned that it would inspire a “race to the bottom” and convince dumbass Canadians into long term mortgage debt even fatter than they are.
What happens if mortgage rates rise?
Say, to five percent?
Or eight percent?
Do homebuyers ever look at those scenarios?
Obviously one should. If you’re buying a house with a 25 year amortization period and expectation, but can only lock in interest rates five years at a time, people who are taking on long term mortgage debt should look at the effects of interest rates moving higher and lower at the end of the locked-in period. Does anyone actually do that?
I’ve taken out and renewed mortgages a few times. I don’t recall ever being shown scenarios on what will happen at the end of the mortgage I’m negotiating if interest rates spike or slump. That’s not really the bank’s concern, of course, so it’s left to me. It’s the kind of thing I do by myself because I’m naturally risk averse, so I look at my mortgage payments five years ahead if interest rates rise to 12 percent, or fall to one percent or end up somewhere in-between. (My wife always has a heart attack when I show her a nine or 12 percent scenario.) These aren’t impossible scenarios, but people always seem surprised by the notion that future prices can be different from today. I got a mortgage in the spring of 2000 at 8.95 percent. I sold that house in the winter of 2001 and got a new mortgage for the new house – at 5.75. A few years later it fell further to 3-something. That’s quite a range, and it’s just recent history. How do you project what’s likely five years from now?
How do I twist this around to fit farmers’ marketing challenges this year? Here’s how: crops get seeded a couple of months from now. They get harvested seven months from now. Most inputs were purchased over the past six months. There’s a whole bunch of financial risk in those time spreads. And today’s expectations could be seriously overturned by what happens this summer, to both upside and downside.
Here are analyst Mike Krueger’s new crop price estimates:
That’s a crappy photo, but it’s an incredible range. How do you hedge for that? What would it do to your profitability if you got the top end of that range on wheat, canola (sub-in canola for soybeans there), or barley (sub-in barley for corn)?
This probably isn’t a year in which the low end of this range would bankrupt piles of farmers, but it could steal-away what presently still looks like one of the most profitable years in history, based on present prices.
The gigantic range – shared by many analysts who spoke at Grainworld and who are speaking at conferences across the world right now – is based on two not-unlikely things happening: 1) the Northern Hemisphere gets a normal crop this year; 2) there are significant crop production problems somewhere, like happened in the Midwest last year. Either one would send the market flying one way or the other. So both scenarios are what farmers have to be prepared to face. They both can’t happen. Neither might happen. But they’re both realistic possibilities and must be hedged for.
How do you do that?
Risk averse farmers, seeing good profitability in the fall based on present prices, might want to just lock-in prices today. Why not? They are very high by historical standards. More adventurous farmers might want to employ options-based strategies to protect downside risk and open up upside potential. And carefree, or paranoid, farmers might want to just leave everything unpriced and unprotected and ride this year’s lightning and take the prices that appear in October or November. The first three sentences of this paragraph sum up some of David Reimann of Cargill’s views that he gave at Grainworld last week. Look at this murky pic I took of his conclusion:
At Grainworld I heard a lot of talk about options and to me this really seems the ultimate year for using options in crop risk management. With such a huge range predicted by reasonable analysts, farmers need to take seriously both the upside and downside potentials of the 2013 crop. Options are a great way to do it. Most grain companies offer options-based programs, some cash contracts offer similar arrangements, and farmers can work with their own brokers to establish options positions.
But whatever you do, in these weeks before seeding, consider crop price ranges like that one above and figure out what either end would mean for your profitability. These aren’t unlikely possibilities.