For most of the Midwest, the dry months of July and August are allowing combines to get into the field much earlier than usual. Corn yields, as represented by the September USDA report, are now below last year and more than likely heading lower. While USDA suggests soybean yields might improve, I would not be surprised to see them retreat a little more before the final numbers are in. In addition, we are finding more wheat in the bins and global production is on the rise, making it harder for wheat prices to rally. Essentially, 2011 will go down in the books as one of those significantly reduced yield event years. When combined with 2010, corn carryover has now moved close to below pipeline stocks. The corn bulls want to stampede, but they are finding it more difficult to push up prices.
Price and usage relationship. In the coming months, there will be a lot of debate in regard to what price is necessary to ration usage. If corn prices get too high, will it attract more corn acres or will producers continue to fight to maintain their corn/soybean acreage mix due to agronomic and operational restrictions? How will strong grain prices impact the 2012 farm bill, which is now being created?
Finally, with extreme pressure being put on Washington to cut costs, how will agriculture budgets be impacted? Keep in mind that a well-fed population is a tranquil population. Politicians want to stay in power, and they know that in the long run we need cheap food, cheap energy and jobs. Don’t be surprised by anything as the 2012 election nears.
The fundamental factors at play today are as potentially violent as I have ever seen. Market volatility will be quite high for most of 2012. As outside money moves in and out of commodities, daily price moves could be very disruptive to many producers who are trying to maintain and build a long-term marketing plan.
To give you confidence to act, let me remind you of some basic elements about agriculture marketing that I’ve come to believe are bedrock assumptions when it comes to understanding long-term price patterns:
1. The best cure for high prices is high prices. When prices get too high, they destroy demand and stimulate production both domestically and internationally.
2. Short crops have long tails. This means we normally see a high price early on confirmation of a supply reduction, which leads to demand rationing and a subsequent increase in production during the next production year.
3. Bulls and bears always get fed, but hogs get slaughtered. If you don’t understand this, you might as well get out of the market.
4. The rule of unintended consequences. The market often reacts in an unexpected way that surprises us. Many times, it acts in a way that disappoints the maximum number of people. In this case, producers will be putting cash corn and soybeans in the bin with no carry in the hope of seeing sharply higher prices the following summer.
While these principles are well known, we seem to want more complex answers to the basic supply-and-demand equation. I believe commodities are produced in an economic structure that will not allow excessive profits to be realized for more than two marketing seasons. While this has been proven to be a little incorrect because of ethanol and the China growth function in the corn market, I believe it will eventually be vindicated. We are about to see a sharp reduction in ethanol production due to the expiration of the 41¢ refinery credit at the end of the year.
While not a factor for 2012, China is making every effort to increase wheat production in Russia and the Black Sea region to gain another supplier of feed. The risk is that when a big wheat crop comes out of these regions, along with a big corn crop, the Chinese will simply buy hand-to-mouth and allow producers to foot the bill for storage and price risk.
Corn sellout. Between now and the first part of 2012, a supply reduction in corn will be the biggest bullish factor, while soybeans and wheat will be pulled up.
Long-term, producers need to become very aggressive at selling expected 2012 and 2013 corn production as the market moves into $350 to $400 returns on investment above all direct and fixed costs. By the fall of 2013, cash values at harvest will be very close to the cost of production.
Cattle and hog producers will be forced to make some hard decisions. With cash corn above $8 and uncertain domestic and global economies, will cattle, hog and poultry producers be able to compete?
This brings us back to "the best cure for high prices is high prices." I sense that inventory numbers will be moderately high for the next three to four months, keeping prices on the defensive as herd sizes adjust. This is good news for the survivors but bad news for consumers; as 2012 nears, we could see sharply higher prices at the grocery store if any stability occurs in domestic consumer demand.
Focus on controlling input costs. Limit downside price protection—say, three to four months at best in a vertical put spread rather than short futures. Protect fall and winter downside risk now in case things get nasty, and be ready for a spring and summer price bounce.
- October 2011