The necessity for managing price risk in the ag sector, as well as non-ag, is likely coming into vogue again. The two-year bull market for grains ended spring 2022 with collapses from lofty levels in $8 corn, soybeans over $17 and Chicago wheat over $13.
The supply-driven bull markets that began in September 2020 for grains have seen gains reset back to those levels. Soybeans have reset 50% of that price move.
The profit-landscape of U.S. agriculture has changed, putting a new emphasis on risk management. Twelve years at 2% inflation and interest rates near zero were an outlier as the chart below reveals.
I lived through the 1980s, when inflation and interest rates were much higher — as did many of those in government and the Fed. While interest rates are not at 1980s levels, capital expenditures for land and machinery are much higher. Return on investment (ROI) requires a new perspective for both depreciable (machinery) and non-depreciable (land) assets.
The Fed is allowing risk back into the marketplace. Gone are the days of the Central Bank “we got your back zero interest policy (ZIRP),” an environment where investing in just about anything yielded more than money in the bank and the cost of money had only honorable mention on a P/L statement. The environment of zero-rates led to popular perspectives of “there is no alternative (TINA) but to buy dips” in assets that returned anything better than zero or money in the bank.
Cash Is King Again
Profit margins will be under attack and enterprises allowed to fail. Banks will let non-performing assets sell at market-clearing levels. The question is whether U.S. agriculture has become too big to be allowed to fail.
This new environment is global. European and socialistic countries face the same issue, while emerging nations will carry new risk of uncertainty as money/investing goes to countries with a stable government, military and economy. The U.S. meets the criteria suggesting a stronger dollar will make our products less competitive. It becomes not who can produce the cheapest, but who will sell the cheapest.
It’s likely managing a slimmer margin in production agriculture will be closer to the 1980s than the 2010s. The danger is in new participants in our ag economy who view the last 20+ years as normal. Worse yet, participants for whom those years were the basis for their entire careers.
The massive infusion of government money the past few years created a sense of apathy toward managing price risk. As a result, the need for risk management might have been grossly underestimated. Our ag economy is also underestimating risk management’s importance in the new environment of positive real interest rates.
Unintended Consequences
This isn’t my first rodeo. I’ve seen a scenario like this before with land and machinery. Investing in land that returned 2% was and is better than zero return on money in the bank. Land has doubled or tripled the past 20 years under the “TINA” scenario. But a 3% to 4% return on $5,000 per acre of land and a 5% return on $15,000 per acre of land are quite different. A $750 per acre rent isn’t practical nor is a $400 rent under $4 corn. There lies an alternative investment vehicle (ROI) now for new money and old money currently invested, especially if normalizing interest rates is the new norm.
The same is true for depreciable assets. Immediate write-offs have been touted by the capital goods industry as economically beneficial, but there is a price to pay if the asset is depreciated fully but not paid for. It takes after-tax income to make a capital payment and depreciation is the vehicle allowing that to happen. Whether it’s land, a home or unwise tax planning, there are consequences. The Fed is sending a message: There are future intended consequences. The future is here.
