Disaster Planning - Part 2

Published on: 00:29AM Jun 21, 2010
I just had to respond to one of my reader’s posts because I read some worry and perhaps cynicism in his or her question, and I wanted to reassure as best as I could. To Anonymous 9:34, here it goes:
If you are concerned about the long-term prospects for American agricultural commodities, broadly speaking, the outlook is good. There is a hungry world population to feed and, at least near-term, demand for alternative ag-based fuels to explore. The American Farmer never ceases to amaze me with the ability to produce to meet demand. That said, I know marketing in an uncertain world brings its challenges. For many farmers—experts at production and not so interested in marketing—these challenges are unwelcome. Yet I believe that marketing is as important a management frontier to tackle as is pest management or any other production technology you may learn.
As a general rule, marketing budgets should be about 10-15 percent of the value of the crops they are protecting. That’s our basic recommendation. The nice thing about the Market Scenario Planning approach (as I described in my last post) is that many times a solid scenario plan that takes care of the most practical price possibilities also works really well for the disasters.
Take this year for example. Using various technical and cycle analyses, "bad news" for corn this year is any of the technical objectives between $1.94 and $2.35. (I know most people may argue that any price lower than current prices is a disaster.) A sound strategy currently might have one covered to the downside by 80 percent or more on the current crop and 10-50 percent on the 2011 crop.
Let's say we look at the 2010 crop and it is 80 percent covered at $4.00 futures price. A $1.00 drop to the $3.00 price level prices out your entire crop at $3.80 ($4.00 on 80% and $3.00 on 20%).
Let's say the market keeps dropping to something extreme, say $1.00. So what is the outcome in that case? Your average price is $3.40 on all bushels when corn is at $1.00 (80 percent at $4.00 and 20 percent at $1.00). Not a bad price for that situation. It was the fact that you had 80 percent covered in some way (cash, futures, options, etc.) that gave you the preparation for “whatever” to happen. The last 20 percent is not going to have a major effect on your average price.
Remember to structure the tools you are using so you have the same potential on the topside, and that makes your weighted average price flexible, allowing you to handle whatever the market throws at you in a very reasonable, cost-effective manner.
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at [email protected].
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