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Market volatility: Here yesterday, today and tomorrow?By Larry Dreiling Just ask anyone who follows them, agricultural markets are in a volatile phase. An ethanol boom and soaring energy and gold prices have combined with poor crops elsewhere in the world to increase the demand for wheat. The U.S. Dollar is tumbling against the Euro and Yen on foreign exchanges, causing institutional investors to seek out grains, soybean and livestock futures as a place for speculation. Take for example the December Kansas City wheat futures market. The December 2007 contract closed Jan. 3 at $5.02. Just before the July 4 holiday, the contract was trading at $6.45. It reached a peak Oct. 1 closing at $9.49 1/4. Like the common cold, market volatility is not just this year's thing but keeps reappearing in different guises. "In the mid and late 1970s, we saw commodity market volatility comparable to today. The Russians unexpectedly bought up most of the surplus wheat in the world and then OPEC shut off the oil, setting off a commodity price cycle," said Dr. Mike Woolverton, visiting professor of agricultural economics specializing in grain marketing at Kansas State University. "Commodity prices did cycle back down as high prices brought forth increases in supply, just as economic theory said it would. The cycle did not end well for farmers, however. High grain prices caused land prices to increase dramatically. Lenders allowed farmers to take on debt in the run up. The downside reduced commodity, and land prices could not support them, which created the farm crisis of the early 1980s." There have been other times when market volatility raised its head, according to Mark Gold, managing partner of Top Third Ag Marketing, Inc. "Lately we've become used to $8 and $9 wheat, $9 and $10 beans and $4 corn," Gold said. "Historically, when this happens, you see incredible volatility, with 40 to 50 cent daily trading ranges. We aren't at that level of volatility. "In 1973, when the Hunt brothers were squeezing the bean market, we saw incredible volatility, with huge daily range swings. There were times the prices would change 5 to 10 cents, in-between trades, at a time. In 1988, during the drought of that era, there were big swings, with limit-up, limit-down activity. We don't see that here, but it's pretty darned interesting." One person who thinks volatility is here to stay for the foreseeable future is Dr. Kevin Dhuyvetter, professor of agricultural economics specializing in price analysis and livestock marketing at Kansas State University. "The thing that is so much different for the cattle market, compared with years past, is the situation with ethanol and biofuels. We're going to have frequent scares where we don't have enough corn; then we'll find out yields are OK. The potential for swings today is at a high and it's going to stay that way. We'll have to learn to live with it." Prices bound to fall For now, Woolverton said this commodity price cycle will stimulate additional production, which will cause prices to fall. "We don't know yet how far prices will fall. Indications are producers, for the most part, have not taken on more debt this time and we should not see another farm crisis like the 1980s," Woolverton said. The marketing specialist added that a factor to watch is corn prices that are higher than many expected at this time, given that ethanol production margins have turned negative. "Demand growth from ethanol producers has slowed, as plants cut back on capacity utilization and new plant construction has been put on hold or has slowed down. Ethanol prices have strengthened a little recently, but margins are still negative. "More wheat production next year should cause wheat to go back into livestock rations at the expense of corn demand. Corn prices will remain strong through the spring in order to hang onto acreage. Even so, U.S. corn acres are expected to decline by about 6 percent." It's not just this ethanol-livestock feed controversy that's stirring the marketing pot, Woolverton adds. Supply and demand fundamentals are being overshadowed in many respects by several global factors. "Economic growth around the world has stimulated demand for all commodities and the weak dollar has made U.S. exported items lower priced to overseas buyers," Woolverton said. "Wheat production around the world was bad this year. The U.S., Europe, China and Australia, for two years in a row, had short crops. Global supply is at a 34-year low; a 59-year low in the U.S. High prices are not bringing forth increased supply immediately, but instead is rationing the wheat that is available until the Great Plains harvest begins next summer." Meanwhile, the U.S., Brazil and Argentina all produced record crops of soybeans in 2006. Acreage forecasts for the U.S. crop were cut by 15 percent last spring. U.S. national average yield was lower than expected. "The increased demand for soybean oil by biodiesel producers was not anticipated. High prices are now bidding more hectares of soybeans into production in South America and should cause more acres to be planted in the U.S. next spring," Woolverton said. "Of course, the big story for corn is increased demand from ethanol producers, but that is not the whole story. Decreased feeding of wheat increased the demand for corn. In fact, demand for all major uses of corn increased, for domestic livestock feeding, exports, ethanol and human consumption. Interestingly, high corn prices did not reduce the quantity demanded." The weaker U.S. dollar will encourage exports long term, which will help prices to a point, Gold said. "The dollar is at near contract lows, encouraging exports into foreign countries. It will also stir up inflation, which is what's going on with gold and crude oil to some extent. We are going to see exports continue to climb." Creating a monster One thing that helped in keeping prices from going even higher is corn technology that has increased yields, Dhuyvetter said. "All of a sudden, we've created this monster that needs a lot of corn. So long as we continue to have increased trend yields, we're fine," Dhuyvetter said. "Everybody is saying, what if we have another drought. We may not have to worry about it with the new genetic technology. I think we've dodged some bullets, but I'm not sure we'll never have another short crop again." That means prices for wheat will likely cycle downward, Woolverton said. "We are already seeing the price of wheat drop, as winter wheat planning nears completion in the Great Plains and around the world in the Northern Hemisphere," Woolverton said. Indications are that planted areas will increase and the weather in the U.S. has been favorable to establish stands. "If growing conditions are good through the winter and into the spring, wheat price will continue to drop. The nearby to July futures contract price spread tells us it will drop at least $1.60 per bushel." Soybean prices, meanwhile, will remain high until the South American crop is planted, Woolverton added. "It has been dry in Brazil, but the rain is beginning to fall in soybean growing areas. If soybean acreage increases in the U.S. by 9 percent, the latest USDA estimate, prices may fall even more," Woolverton said. Making a plan Establishing a marketing plan is difficult enough for many producers, but is particularly hard on cattle producers, primarily because of how feed is purchased. "The cattle feeder normally buys corn on a month-to-month basis. It's somewhat hand-to-mouth," Dhuyvetter said. "That in itself is a risk management tool. The need to manage around that is going to increase, because volatility will be the word." Of the major grains, Woolverton insists wheat prices look to be the most vulnerable to a price drop. Corn and soybean prices will be supported by continued strong demand, but may be supported at lower levels than were seen this fall as supplies are adjusted to meet demands. Then, there are the unknowns that may affect the markets for grain and oilseeds. "Weather, as always, is the biggest unknown," Woolverton said. "We saw a terrific wheat crop in Kansas devastated this past year by freeze and too much rain in parts of the state. No one can predict what this spring will bring. "A developing La Nina may cause the Southeastern U.S. drought to spread into the Corn Belt next growing season. The U.S. and global economies appear to be slowing down, which may cause demand to slacken. Unrest in the Middle East would shatter everyone's crystal balls." Another worry is about government and the outcome of the 2007 farm bill, Gold said. "Risk management tools are at risk when members of Congress see high prices and are looking to save money to pay for wars and big natural disasters and Katrina and California wildfires," Gold said. "The thought from many on the Hill is the farmer doesn't need our help right now. But prices will likely go down in six or seven years. Congress has the same logic as farmers do sometimes. They think prices won't go down, but they do. Leave it to government to do exactly the wrong thing at exactly the right time." All these factors make it imperative that producers have a good marketing plan in place. "I have seen analysts predict markets based on supply and demand, only to be caught off guard by wars, droughts, freezes, nuclear scares, embargoes, mad cow or Oprah," Gold said. "One of the great assets of a marketing plan is the peace of mind it should bring you everyday; knowing whether prices collapse or explode overnight, you are either protected on the downside or in a position to make a fortune on the upside." Adds Dhuyvetter: "Risk management ties back to exactly what you are doing: Feeding cattle, backgrounding them, selling calves, buying corn and having storage. It's easy to say, 'I don't routinely buy put options.' It's a lot more than that. It's a combination of decision making about production, along with intelligence about marketing. Knowing breakevens allows you to put yourself in better position to make those decisions." More and more bankers around the country are embracing the use of commodity options as a formidable tool in managing risk, Gold said, and he applauds bankers who work hard to make producers profitable. "Risk management for producers is really a tri-party endeavor," Gold said. "It takes a farmer willing to accept new concepts, a banker willing to finance those concepts and a risk manager to develop a market plan and to help choose the best tools for the job. "Most producers have put together a great team to help them with production. They just need to make sure they also put together a team that's looking to help them with the marketing, as well." Larry Dreiling can be reached by phone at 785-628-1117 or by e-mail at ldreiling@aol.com. 11/19/07 Date: 11/15/07
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