High Grain Prices are a good thing, right?
by Elizabeth Armstrong

High grain prices are a good thing, right? After all, aren’t low prices the reason we lobby for stabilization programs and complain to our bankers about interest rates and loan options. It’s about time the tides turned in the producer’s favour to make up for low price years. So instead of cheering, why are we in a state of chaos, uncertainty and frustration?

These markets are new ground for everybody, small scale farmers and multinationals alike. It is expected that with high prices, along comes higher input costs. Fertilizer, spray and seed prices as well as machinery costs not only move up in dollar value, but often become short in supply. Land prices rally and the competition is on.

There has been a plethora of powerful influences jumping all over this market: currencies, ethanol and bio-diesel, oil and gold prices, feed usage, US economy and its mortgage and bank crises, commodity competition and outside speculators. Each category is pushing and pulling to stake its claim on profits, and any combination has been spinning commodity prices in all directions. Books will be written on this time in history.

Locking in forward prices has been an effective pricing method that we have been able to use to our advantage in the past. Times have changed. Why can’t we sell our forward crops to commercial elevators this year….like before? The short answer is the inability to manage risk by offsetting these purchases in the futures market…..like before.

First, some basics. Hedging (buying and selling) is the industry price risk-management practice of off-setting cash transactions (like purchases from producers) with an opposite futures transaction (like selling the appropriate futures month). This futures position is now an “open position” in an account until unwound or closed (like selling to an end- user). While this position is still “open”, daily Margin Calls are made, requiring enough money to be in that account to protect against losses. Typically, the market fluctuation is such that the margin call requirements swing back and forth creating stability (like a revolving demand loan).

For example, if an elevator contracted new crop wheat at $5/bu last fall, and sold July futures at $6/bu, and July futures run up to $12.70/bu. as it did in February, the elevator has to pay that $6.70/bu difference into its hedge account. It continually pays this fluctuating difference everyday, without any return until the wheat is sold and the futures position is closed.

We have been watching the US mortgage and bank problems like side-line spectators, while we have been, in fact, unaware participants. How so? More basics. Speculators: those who buy and sell in the hope and anticipation of fluctuating prices for the sake of large gains. They DO serve a useful purpose by bringing the extra volume to provide liquidity to a market. But the US mortgage and bank speculators have bailed out of that market and entered into this market with such incredible force (and funds), that the volatility has been extreme and erratic. Those same banks and brokerages houses that were shaken up in the US housing markets, are seeing the enormous assemblage of fund speculators bail in packs, and chase the next up-and-comer: the agricultural commodity markets. They’ve been reminded that high risk markets can result in culling players and huge losses, so they tighten up policies and limits for protection. When March Minneapolis wheat futures ran up to $25/bu on Feb 25/08, it was quite apparent that it was not a “real” value. Outside speculators were rushing the market, with actual end-users on the sidelines gasping is disbelief. Cash buyers at these levels were non-existent and the hedge process became ineffective.

The futures market is vital to the livelihood of the grain business, and such action both increases the cost of doing business, and limits participation.

It is important to realize that the futures market does not set the price of grain; it acts as the vehicle for price discovery and reports it on a public platform, ideally driven by supply and demand. The current non-ag based investors will chase this market until the next new epiphany. Meanwhile, as we try to conduct business-as-usual, there are limits, just as in operating and demand loan management, that the system will allow in margin call capital.

“Markets and circumstances are changing constantly. No one is bigger than the market”.

-Lorton/White