The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Returns Revert Back to the Mean
Jan 27, 2011
The first presentation at the Top Producer seminar today was done by Sterling Liddel, a vice president of economics at Rabo AgriFinance. The slide that stood out to me the most was the long-term mean price for corn over the last 80 or so years.
For about the 40 years before the Russia price shocks of the mid 1970′s, the long-term price trend was around $1.00 to $1.50. Over time, as yields and efficiencies increase, the long-term price tends to trend down slightly. From the mid-1970′s until a couple of years ago, the long-term trend price was about $2.50 to $3.00 with much more volatility around the mean price.
We may now be in a new long-term trend at higher prices. We probably do not know what these new trend price might be, but we must remember that the market will efficienty strive to bring that price back down to provide a normal mean return to the farmer. The market will generally allow an excess return for only a few years, but eventually this market will get those prices back to this long-term trend.
We were discussing this with some farmers around the dinner table tonight and this worries them that most pricing assumptions made by newer or younger farmers is building in the "new normal" returns and that they will continue for a long time. If you are making land purchase decisions based upon an average of $5 corn and $11 beans, you need to also run your numbers at $3 corn and $8 beans. If you can fund those prices without stressing your operation, then it may be OK to make the purchase. However, if those prices stress the rest of your operation, it will probably make more sense to hold off and build up your working capital to allow a purchase later on.
Believe or not, more farmers go broke when prices are high than when they are low. They try to leverage up to get those additional acres and lose out when the margins they built into their assumptions evaporate. Be careful in your assumptions.