A black swan is an unforeseen event that typically has extreme consequences. The financial industry was hit with such a black swan with the shuttering of two high-profile banks: Silicon Valley Bank and Signature Bank.
Will agriculture become an unintended consequence, again? I say again because our current financial malaise happened in 2008 and the 1970s.
The value of capital assets and cash flow were concerns in 2008 — just as they are today. The evolution of dealing with inflation has yet to impact ag directly, but history shows a wake-up call is in process.
The crisis of 2008 had a demand destruction impact with corn prices losing nearly $5 per bushel, ending at $3 — the low for the following 15 years.
Supply constraints of the drought years of 2011 and 2012 peaked corn prices at $8, which is where demand destruction began. It also kick-started global competition from South America and Ukraine. All this happened with a backdrop of increasing economic stimulus and a cost of capital that was basically free.
Corn prices spent the next six years below $4.50, while demand began building and the government spent money like a drunken sailor. Eventually, corn exceeded $4.50, then $5.50 and then $6.50.
This price appreciation ushered in record ag profits — leading to a mindset that managing price risk was not needed as prices seemed to have reached a new plateau.
The current price structure (see chart above) suggests $5.50 corn could be a reality with the former $4.50 ceiling a critical support.
ACID TEST
Silicon Valley Bank invested cheap money in better-yielding long-term assets (bonds), while ignoring long-term cash flow implications.
Outside investors sought the same in land, as land is similar to a bond. In the past decade, land was purchased with the goal to yield 2% to 3% ROI (in rent) versus idle cash yielding around 1% — a no-brainer.
But land prices and interest rates exploded. In this inflationary environment, the ROI bar has been set higher, as there are alternative investments available.
Equivalent rental rates (ROI) needed to compete with higher interest rates are likely unsustainable. The value of farmland might not support the value on the balance sheet. (I encourage you to dive into acid-test ratios for your land, which shows if you have sufficient short-term assets that can be converted to cash to cover short-term liabilities.)
There is ultimately a price to pay for cheap money. The corn chart says there is a possibility we might have to deal with $4.50 to $5. In fact, $5.50 has already been printed for December 2023 futures.
Pending the Fed’s inflation fighting resolve and global demand, we might have only seen the tip of the iceberg of problems. If my corn chart analysis is close, cash flow projections for 2023 show a drop of $200 to $300 per acre in profitability and could be insufficient to service debt interest plus make after-tax payments on principal.
Disclaimer: There is substantial risk of loss in trading futures or options, and each investor and trader must consider whether this is a suitable investment. There is no guarantee the advice we give will result in profitable trades. Past performance is not indicative of future results.
