September 23, 2011
If you are a farmer…
A few thoughts about hedging, immediately, these historically high prices…
A few observations after 31 years in commodity futures…
Let’s start with this: Nobody ever knows where a market is going to be six months to a year in the future. NOBODY. Let’s also be sure to understand that NO MATTER HOW BULLISH (OR BEARISH) all the fundamentals supposedly are, it absolutely does not mean a market is going to do what everybody thinks it should do. In fact, as we all have experienced, it often does very much the opposite.
These are easily the most volatile markets any of us have ever seen. Whether it’s stocks, bonds or commodities, all the speculative money sloshing around the world has turned the markets into something akin to casinos in which rapid 25-35% changes in prices have become almost commonplace…like Cotton for example. Six months ago, with Cotton looking like a rocket, and blowing through $2.00 as if it would never stop, I was actually hearing comments like, “There is no cotton left in the United States”, and the overall sentiment towards this crop was as bullish as anything I’ve ever heard…But then what happened? It cratered and three months later we’d seen July go from $2.00 to $1.35 (-32%), even while we were in the midst of the worst Texas drought in a century and seemingly every analyst out there saying “Buy Cotton” every inch of the way down…Or just as one more example, look at Wheat back at the beginning of the year…There were weather problems ALL over the planet, to the extent countries were even forbidding exports of their own wheat supplies. All the news, and the price forecasts, were wildly bullish…but just like Cotton, we saw July 2011 Wheat go from $9.40 in February to $5.70 in July, or almost a 40% drop in about 4 ½ months.
Did you, or anybody you know, see this coming? I doubt it.
The bottom line idea here is, again, NOBODY KNOWS WHAT IS GOING TO HAPPEN…and even if you do have suspicions a market is overpriced (or underpriced) you still never know, until after the fact, if you are right OR have any idea as to what the timing of a move will be.
If you are an agricultural producer, the first thing I am going to show you, through some long term charts, is where prices are historically…and along with these charts, point out that EVERY bull market, EVER, has come to an end…I don’t care HOW bullish all the supply-demand fundamentals are, there is not an ag market in history that doesn’t routinely go from high prices and people thinking, “There’s not enough to go around!” to low prices where you hear things like, “It’s under what it costs to produce it!” or “We don’t have enough storage to hold it all!”…which I’m sure all of you have seen and heard yourselves.
Believe me, I am not some sort of ever pessimistic guy (I’m really very much the opposite), but I do think that any farmer who doesn’t keep in mind that bull markets DO end, and have some sort of price insurance especially today when it costs so much to produce a crop, is truly risking the loss of his business…
So here are those long term looks…about 40 years worth. The one thing to note is how all of them go up AND down…And again, to remember, that at every one of those tops, virtually the entire commodity world was thinking, “Gonna stay up” or “Going higher”.
And do note how all of these markets do routinely turn around fairly quickly…Usually when they are up, they don’t stay up long…and when they do start lower, it is often relatively STRAIGHT down…It make take them some months to get their but the sell offs are often relentless…If you wait for rallies to sell into, they don’t always come…
I started this thing, especially for farmers, with the idea I would go into some options strategies, but in the interest of getting this on the website tonight, am going to just leave it here with this big picture outlook for the moment.
What I will say, briefly, is that if options and futures are confusing to you (puts, calls, strike prices, premiums and all that) I can assure you they are quite simple to work with. The truth is, I rarely use futures contracts and probably 95+% of the positions I take are just buying calls (thinking the market will go up) or puts (thinking the market will go down)…This means I know exactly what my risk is, that whatever I have paid for the option is the most I can lose...This is what I believe makes options so attractive as a tool for protecting yourself against falling prices if you are a producer. You can buy a put option, know what price you have locked in, and if the market does fall out of bed, you won’t find yourself finally being scared into selling your crop into the lows…Conversely, if, for example, I am dead wrong about Soybeans, and they zoom off to something like $17.00, you WILL have lost the maybe 50 cents you would spend on a put as protection, but then you’ll also be selling your beans for $17 instead of today’s $12.75…If that’s all Greek to you, I promise you I can clear it up completely in one phone call. OPTIONS AREN’T COMPLICATED. They are not free, but they are very much like price insurance and they do give you tremendous flexibility…no matter which way the markets go.
Just for the sake of getting at least one real world example out there, here is one possibility in Soybeans using today’s close.
With Beans having made that recent "fakeout breakout" through $14 up to $14.75...and then collapsed through the lows of the last 6-7 months, I think the odds are high this is turning into Wheat or Cotton from earlier this year...We ARE headed towards harvest and I do have the impression there are a LOT of farmers who were waiting for $15 or $16...and are going to get more and more anxious/nervous if prices keep dropping...You've certainly seen this scenario before where everybody's hoping for just a little higher prices, then it doesn't get there, then they keep hoping for "one more rally"...and it never comes...The next thing is everybody, all together, ends up selling their crop deep in the hole...
So here is one quick strategy…
I’ve been writing this piece for most of today, and would like to go into more detail, but will have to leave it for another newsletter. The bottom line is, I started putting this together, specifically for farmers, because I believe your risks are currently tremendous. Yes, I’m just some guy in Kennesaw who has an opinion, and I will be the first to tell you, “Maybe I am dead wrong”, but in my 31 years doing this, I have seen this scenario too many times before…where the whole ag world is looking for higher and higher (and higher) prices…then the next thing you know, the markets are on the floor…etc., etc…Lastly, I’d say this…We are heading dead into harvest and whether or not supplies ARE actually that tight, right now, FOR THE NEXT 2 OR 3 MONTHS, THERE IS NO SHORTAGE OF CORN OR BEANS.
I would add that I also strongly recommend doing something to start now to lock in some of your production for 2012.
Do give me a call or email if you want to talk about any of this. I assure you I am easy to talk to and think I do a good job of explaining how this stuff works, no matter how little you already know about it. And as I noted in my card, I know you guys work until past daylight so feel free to call me nights or on weekends.
Also, if you would like to receive this newsletter regularly, at no obligation, please let me know either by phone, mail or email.
I write this newsletter on no particular schedule…but I will be soon be following this with specific hedge recommendations in other markets (including for 2012 crops), as, one more time, if you aren’t covered on the downside, I think you need to be doing so immediately.
Toll free 866-578-1001
Email is bill at crokerrhyne dot com (if I actually put it in normal form, I get a million spammails)