Did you hear the news? The experts were completely wrong this summer.
Most professional analysts from the well-known private firms to the major international grain houses were convinced soybean futures were going to trade below $8. They certainly made a compelling case.
Instead, November futures rallied to just under $12. The corn market followed, trading above $4.40. The cotton market unexpectedly rallied 10 cents in four days, catching many in the trade short, then bounced another 4 cents.Steve Scott
Prices eventually came back down, but it was a tough summer for anyone in the business of predicting prices. It was also a tough time for farmers who followed their advice.
For those paying attention, the markets are again trying to teach farmers an important lesson.
You will have a hard time achieving marketing efficiency if you continue to base your decisions on a price prediction, even from the experts.
How many examples do we need? Futures markets by their very nature are unpredictable.
Professional traders continually factor in what is known and what is expected, which means the prices that flash across your screen reflect their best educated guess at that point in time. That included the prices we saw last spring.
But unexpected events come along and prices change. Trying to predict unexpected events goes by a familiar name, it is called guessing.
If you base marketing decisions on price predictions, some years you will guess right and do fine but other years you will guess wrong and the results can be disastrous.
Reduced farm bill protection means you will now pay a much bigger price for your marketing mistakes.
Here is the good news, you do not have to successfully predict price direction in order to be successful with your marketing. A farmer can achieve a high level of marketing efficiency without having a clue where prices are going. It requires an understanding of the marketing tools available and, for most, a fundamental change in philosophy.
First the easy part, changing philosophy. The concept that futures markets are unpredictable is not an original idea. Farmers who have been in business for a while instinctively know that is true. They have seen the experts proven wrong too many times.
We would like to think there is someone who can tell us where prices are going, but logic tells us that is not likely to be the case. If someone could accurately predict prices, why would they tell us?
So why do most farmers continue to base their marketing decisions on a price predictions? It comes down to limited choices and a misunderstanding.
Most farmers work with only two marketing choices: either sell and lock in a price or don’t sell and stay at risk. If they sell too soon and prices go up, they miss opportunities. If they sell too late and prices go down, they are subject to a very bad outcome.
Working only with those two alternatives, farmers feel they must try to time their sales. What they overlook are strategies that fall in between the sell or don’t sell alternatives.
Downside protection + upside potential… Since no one truly knows where prices are going, I have found the most consistent strategy is to look for opportunities to protect the value of production from falling prices while maintaining the ability to participate should prices trade higher.
There are two ways of doing that. You can price crop and buy calls and you can buy puts to protect expected production you are not willing to book. That is it, there are only two. Granted, timing is important and requires some expertise, but the strategies themselves are not as complicated as you may think.
Now we come to the misunderstanding. Options have been available as a marketing tool since 1985, yet they continue to be misused and misunderstood. It has to do with purpose.
If your primary objective in buying options is to generate income, you will likely be disappointed. Options are priced to the advantage of the writer not the buyer.
But if your objective is to manage risk, options are the most important and versatile marketing tool you have in your toolbox.
2016 soybean strategy… November futures spent most of last winter quietly trading around $9. With the volatile growing season yet to come, our suggestion was to buy relatively cheap calls with the hope we would have booking opportunities later in the season. Those opportunities came and our clients found it easy to pull the sell trigger knowing the calls were already in place.
When prices traded sharply higher, some clients cashed in the calls while others rolled to a higher strike and pulled some money out of the market.
In both cases, they were able to add revenue to their early bookings.
As for the expected balance, the market rally gave producers many opportunities to lay in puts which provided important price protection. Had the summer rally continued, the calls plus unpriced production would have benefited. As it turned out, the bookings and the puts saved the season.
Here is the important point
The calls were not suggested because we thought prices were going up, they were bought to set up sales opportunities. The puts were recommended to protect a specific price level, not because we thought prices were going down. The strategies allowed our clients to successfully market their crops without having to be right.
The usual caveats apply. While it was not the case this season, options will often expire worthless. It is important that a farmer understand how the strategies work and only use funds not needed for production purposes.
Listen to the markets. You will do much better over time managing risk rather than predicting prices. The tools are there. It is a matter of learning how to properly use those tools and truly accepting what is possible and what is not. When it comes to accurately predicting prices, there are no experts.
Steve Scott is president of Scott Agri Crop Marketers in Arkansas. Email him at [email protected].