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Outlook: A Tale of Two Economic Opinions

November 12, 2011
By: Bob Utterback, Farm Journal Columnist
 
 

BobUtterback Oct2011I don’t tend to sugarcoat my opinion about the markets. As a result, I have gained the reputation of being a bear. However, my primary objective is to help readers merchandise their grain, rather than make them bullish (speculative), so I proudly wear the title of Mr. Bear.

Since 2008, the grain markets have experienced some of the wildest price moves since the early 1970s. It’s getting increasingly harder to figure out the markets because not only do we have the annual changes in supply due to crop mix and weather, but we now have the influence of ever-changing domestic and global demand.

A look ahead. There are two opposite opinions floating around about the health of the U.S. economy. The first opinion, shared by the current administration, mainstream economists, Wall Street and most business owners, is that we are merely in the bearish portion of a normal business cycle. Now that the war is winding down, we need to turn our attention to U.S. economic issues. With enough fiscal and monetary stimulation and the rich paying their fair share of taxes, the economy will quickly move back to its hay days. All we need is to have faith in the politicians, spend like we mean it and be patient!

The opposite opinion suggests the game is almost over. After decades of living beyond our means, the bank account is empty and the bill is due! While there is some difference over how long it is going to take, in general there is a common agreement that dark economic times are ahead for the bulls. This type of doomsday discussion is not new, but people are starting to notice that the economy is not bouncing back like it has in the past. Equity in housing and retirement plans is dropping, the cost of living is going up and Washington seems clueless as to how to fix it.

People who are much smarter than me are trying to figure out which opinion is correct. All I can tell you is, the years ahead will be violent—which makes concentrating on the bottom line more important than ever.

While we hope the bullish perspective is correct, what if the bearish side of the equation has merit? Would it not be prudent to lay off some risk, just in case? It might be a good idea
to explore the following strategies for the next three to five years:

  • Real estate, especially houses, second homes and commercial property, could come under extensive price pressure. If you’re not attached to the property, consider using any price bounce to move excess leverage assets as we move into the 2012 presidential elections.
  • If borrowing at short-term variable rates, look into getting interest locked up at fixed rates. If that’s not possible, consider selling 10-year or longer notes as a cross-hedge to long-term interest rate exposure.
  • Next comes the hard one: buying farmland. For several years, I’ve said farmers should buy land; I now believe we are getting closer to a top in the land market. It might be two to three years off, but it is coming. So unless it’s a total cash purchase, don’t buy land much past 2012.
     

Is there any way to take advantage of this possible bearish environment? Yes, by aggressively selling stocks on rallies; now is the time to be liquid and focus on cash accumulation.

I believe politicians will tolerate inflation before they accept deflation. The longer they can postpone the problem, the more it will be somebody else’s problem. As a result, I like the buying gold, selling bonds and dollars route for the next few years.


Sales index:

10 = Excellent sales opportunity

1 = Excellent buying opportunity


As you move into 2012 and think about the supply-and-demand structure of agriculture, don’t forget these two opinions have completely different outcomes. It’s crucial that a market plan has enough flexibility to respond to economic events as they unfold.

Corn: 7

Spreads are narrowing, basis is red hot and corn harvest is barely 60% done as I write this column. It is obvious end users want corn now. Pro-ducers, on the other hand, are saying
if the market is this strong now, let’s wait until spring when weather becomes an issue. If the rumors are right, producers are storing their corn and holding onto it until next year.

Now that $7 cash corn is quickly becoming a reality, move the grain. To re-own for a June-to-August weather scare bounce, use the cash-flow movement of January to March to re-own in a limited risk strategy.

In regard to expected 2012 inventory, if all inputs have been purchased and the current $6 corn price allows for $200 to $250 in profit above all costs, start selling enough expected inventory to cover input costs.

This, however, is where many producers go wrong. They want to sell cash so they don’t have to deal with margin calls. Instead, consider buying deep-in-the-money puts at the maximum cash-flow risk you can assume. Consider the December 2012 $7 puts at $1.30 or better. I know it’s a steep premium cost, but this amounts to buying value and getting time value cost down below 35¢. Then be prepared to roll up the put if the market rallies.

Finally, in late June or July, when we have a better handle on supply, roll the put into a short futures position or cash sale. Remember, if we do have a weather event and the market explodes next summer, there is a loss on the long put, but the cash value is going up.
 

Beans: 7

The uncertainty about demand from China and the general expectation that yields will be up in the November report has put a lot of pressure on soybeans. Some farmers still have soybeans
on hand. With January beans almost below $12, it’s difficult to sweep the bins. Therefore, I reluctantly suggest holding soybeans and looking for limited seasonal strength into December. Be realistic, though; a move above $13 will be difficult and a move above $14 will take confirmation that there are supply issues and China’s export demand is picking up.

It’s hard to get excited about 2012 crop sales, even though a modest profit does exist. Consider buying $13 or higher puts to get a low time-value cost and roll up as in the corn strategy outlined on the left. Buy enough puts to cover the variable production costs.

Wheat: 5

I assume those following my wheat hedge strategy have parked all hedges in the December 2012 contract to take advantage of carry incentive. If all variable costs have been covered, buy July 2012 in-the-money puts.

Cattle: 2

The cattle sector is most influenced by outside markets and consumer income. How much are consumers willing to pay in these economic times?

Focus on protecting the downside with a vertical put strategy. Implement the downside strategy if short-term support has been taken out and the 18-day moving average has been violated. Be cautious in protection, but be ready to act quickly.

Hogs: 5

Hogs are facing the same positives as cattle—low inventory and solid domestic and global demand—but it’s uncertain how long the party will last. We know hog supplies can grow faster than cattle, so it is necessary to be a faster seller of hogs. June hogs are strong enough to run a trailing stop on selling right below the 18-day moving average.

Bottom line: As long as the market is going up, don’t be short; but be ready to protect at a moment’s notice. Remember what happened to the corn bulls this summer—the best cure for high prices is high prices! If the general economy bears are correct, consumers might want beef and pork but they won’t be able to afford it. This means the only way to capture the current gains is to be heavily short—be long in-the-money puts and roll up systematically if the market does rally.

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FEATURED IN: Farm Journal - Mid-November 2011

 
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