Know the danger areas for 2013 and reduce your risk
Who could have predicted a year like 2012? One of the worst droughts in history parched nearly the entire country, yet farmers, in general, will be better off financially than they were in previous years.
USDA estimates that net farm income, which includes total returns after expenses, will exceed $122 billion in 2012, up 3.7% from 2011. High grain prices and crop insurance indemnity payments are reported to be behind the dramatic increase in profit.
But as easily as profits go up, they can come down. "Right now, the market is really nervous," says Bob Utterback, Farm Journal Economist. He adds that the drought has left the U.S. with short supplies, uncertain demand sources and volatile grain prices. Macro market elements such as the slow economic recovery and low consumer confidence are also at play.
Some would say that black swans are on the horizon. But while many of the potential economic dangers are easy to identify, they are hard to prepare for. A number of the reasons farmers have been profitable in the past few years—high crop prices, low interest rates and a competitive farmland market—can easily be reversed.
Danger #1: Economy stays tepid.
Agriculture has been a bright spot, while the overall economy has been wavering. Kevin Kliesen, business economist at the Federal Reserve Bank of St. Louis, says the economy has continued to improve, but the gains have been lackluster and uneven.
He says unemployment is going down, but consumers have been cautious with their money. Additionally, higher oil prices, policy uncertainty and the legacy of the financial crisis are still contributing to the slow economic recovery. "It’s going to take a while for things to unwind," he predicts.
Overall, Kliesen says, the stagnant economy is killing confidence, but he expects it will eventually turn around. "The economy wants to return to its normal rate of growth. If European and U.S. policymakers get their act together and we lose some of the uncer
tainty, the economy could take off."
Danger #2: Crop prices fall.
Prices peaked at all-time highs this summer, with corn surpassing $8 and soybeans topping $16. They have since settled lower but are still at impressive levels.
What could make prices drop? A huge crop next year. Top Producer columnist Jerry Gulke says this year’s high prices will likely attract a large number of acres, especially corn, next year. "Corn prices were extremely high at harvest time. Farmers made money even if they didn’t have crop insurance. You can multiply $7 by just 100 bu. and you should still have made money," he says.
Additionally, farmers were likely not totally shaken by this year’s challenging growing year. Gulke, who farms himself, says he now knows his worst-case scenario for corn yields.
"I can grow 80-bu. corn, come hell or no water," he says. "That tells me that my risk, if I watch my management practices, is pretty low."
The hazard for farmers in 2013 is thinking that these high prices are the new norm. "We have fallen in love and think this is a whole new level of existence. Look at the last five years of prices; it wasn’t too long ago that we had $5 corn," Utterback says.
Corn prices made some impressive dips and peaks in the last decade. Top Producer columnist Jerry Gulke says supply concerns drive the corn market, as noted above.
Danger #3: Hypothetical farmland bubble bursts.
As farm income increased during the past few years, so did farmland values. Many farmers are using their wealth and reinvesting it in their operation through farmland, explains Doug Hensley, president of Gorsuch-Hensley Real Estate & Auction in Canton, Ill.
"Farmers are definitely the ones driving land prices to where they are today," he says. "What alternatives do farmers have for cash right now? Farmland is one of the investment alternatives that farmers are both familiar and comfortable with."
Hensley expects the farmland market to stay strong into next year because many farmers are buying land with cash and aren’t building debt. "Farmers are as healthy today as they have ever been from a financial perspective." Yet, he says, if crop prices drop significantly, the farmland market could soften.
Gulke says the current farmland market could share some characteristics of the 1980s. He says he will be watching the rate of increase in land prices, year over year. "A 3% to 4% rise in prices is still a rise, but a far cry from that seen recently. A slowdown in the rate of increase was a precursor of things to come in the 1980s," he adds.
Danger #4: Interest rates go up.
For those who were farming in the 1980s and saw interest rates reach double digits, today’s rock-bottom rates are almost unbelievable. And they are set to stay low.
Kliesen says the Federal Reserve Bank will keep interest rates down until mid-2015, but the policy can be changed at any point: "Another three years of virtually 0% short-term interest rates is something I never thought I would see in my Fed career."
By keeping interest rates low, the Fed hopes to support housing and boost employment. Will it work? "This is not a silver bullet, but should produce positive effects," he says.
Hensley says an increase in interest rates, in combination with falling crop prices, could spell trouble for farmland values. "Interest rates will go up at some point, and corn prices aren’t always going to be $7.50," he explains. "That’s when you’re going to see things tighten up, but I don’t think we’ll see a crash."
Danger #5: Another major weather event.
In 2011, a wet spring and scorching July trimmed crop yields, and yields were dramatically hindered in 2012 by prolonged dry, hot conditions. It took both of these big, bad weather events for us to see extremely high prices, Utterback says.
Another excessively dry or wet season in 2013 will either support or crash prices. "The biggest mover of the market for grain is weather," he says. "It’s simple: If we get good weather, prices will go down. If we get bad weather, the markets will go up."
Poised to Make Profits
The farm economy goes through cycles, some of which are good for farmers and most of which are tough, says Moe Russell, Farm Journal columnist. "Generally, good times don’t last, and I think we can learn something from that," he adds. Russell offers the following four tips:
- Secure your working capital. "Working capital is the first shock absorber for future financial bumps in the road," he explains. Build your working capital to the level of 50% of your expenses.
- Take a profit when it presents itself. If you do that, Russell notes, you’ll never go broke.
- Refinance real estate or machinery to free up cash. "Take advantage of the 60-year-low interest rates," he says. "Don’t reborrow operating debt."
- Learn from bad years. "Go back and model the worst year you’ve had in the past 15 years. See what you’re going to have to do to survive, if that happens again," he advises.