There’s a market adage that “markets will rally until they don’t.” Simply put, when a price trend becomes established in a market, the path of least resistance is in the direction of the trend. Buying attracts more buying; selling attracts more selling.
Longer-term price trends can stall without a major fundamental happening, which normally points prices into a sideways trading range — a pattern that history shows can last through multiple crop years. But to change a trend, it takes a major fundamental switch.
The Price Path
Sustained periods of “low” prices are usually the result of consistent production and steady, but slow, demand growth. End-users become complacent — instead of maintaining long-term coverage on expected needs, coverage becomes short-term in anticipation of even lower prices in the days, weeks and months ahead. Then when faced with a supply shortfall and a “bump” in prices, end-users begin to extend coverage, but are normally left chasing supplies and driving prices higher.
The combination of tighter supplies and tough-to-slow demand turns into the scenario presented by USDA at the 2021 Ag Outlook Forum: an extended period in which supplies are balanced with demand. That means carryover and stocks:use ratios remain at stubbornly tight levels, leaving markets vulnerable to supply-side scares in upcoming growing seasons.
Until (here comes another old market adage) “high prices cure high prices.”
I was on stage on the final day of the 2012 Pro Farmer Crop Tour when corn prices posted their all-time high. I made a simple statement that, “I don’t know if $8.40 corn is good for anybody in the long-run.”
I did not figure that would be the start of one of the most persistent bear markets in my career, but it was. Corn price drained enough margin from processors for a long-enough period of time that demand was destroyed. High prices did their job — they erased the need for high prices.
Tight-Enough Supplies
In my judgement the markets are very early in this process, and USDA’s balance sheet projections for the 2021-22 marketing year suggest the 2022-23 marketing year will start with tight-enough supplies to leave markets vulnerable to supply-side shocks. And – as in 2012 – it may take a serious crop shortfall somewhere in the world to force demand destruction. Once that happens, hit the reset button and start the process over again.
I am not saying prices are high “all the time” in this scenario – but I am saying prices normally offer at least one opportunity a year to lock in solid profits in this scenario. Until it doesn’t.
As we’ve discussed many times on AgriTalk, current fundamentals and the balance-sheet trends from USDA demand you maintain pricing flexibility. Don’t allow profit opportunities to pass without pricing at least a portion of production. But employ put options and minimum price contracts – strategies that establish a price floor without capping price potential.
