Special Report Archive
Opinions and Their Failures 6/9/16
Enrolling your grain production in any marketing program based on opinion is short-sighted. Let us be clear; our intent is not to begrudge any person’s performance. Our intent is to show that there is a better way to address risk and profitability than opinion based approaches. Opinion based marketing tries to take known data in order formulate price direction.There are too many variables and unknown factors to project price consistently and accurately. Risk management with directional bias discredits market potentials, limits opportunities, and discounts operational specifics.
One of the greatest risks to sustainable profitability is confirmation bias. This means you will seek out what you want to hear. Opinion based marketers choose the bull or bear camp and align their thoughts and convictions accordingly. In spite of market movement they will cling to their opinion over reality. Directionally biased strategies are gambling a grower’s price with preconceived opinions. Many large grain companies use opinion based approaches with their managed bushel programs.
The cost of these marketing programs vary. Some large managed bushel programs charge 10-15 cents/bushel. That is over 10% of last year’s entire corn range, right off the top! These “market experts” try to impress with their knowledge and grasp of fundamentals and technicals. If someone knows nothing about your cost of production, expected yield, or crop insurance policies, how can they tell you when and where to market? Their advice is based on assumptions and opinions, not operational specifics. The attachment to opinions drives emotions. When the market goes against their bias, they will defend and throw their analysis at you. They will miss opportunities while defending their opinions.
Historically in the agricultural community people have been accustomed to discussing price. This is a flawed approach for marketing grain. Price dependencies beget opinions and opinion based strategies are missing the point entirely. As an industry, too much time is spent on things that can’t be controlled such as price, weather and yields. It is a liberating moment when you accept that price, yield, and weather are out of your control. If anyone has a chance to succeed at price projecting it should be the large, multinational grain companies.
A pension fund consultant commented on one grain company’s foray into proprietary trading in 2012.
“As a result of their position as dominant player in the agriculture market, this fund seeks to take advantage of the fundamental market insights and replicate the firm’s proprietary positioning in the futures and listed options markets.”
That fund was closed in 2015. That same company now manages bushels for thousands of growers across the country. They are not confident enough to trade their own money but are willing to charge a high fee to speculate with your bushels. When the largest grain companies in the world are failing at price projecting, why would anyone else expect to succeed? No matter how “connected” a person or group might be, no one can outguess the market.
There is a much better way to manage revenue on the farm. The question should be “how do price and yield scenarios affect my operation?” AgYield will address the potential outcomes and create a well constructed revenue plan. A well constructed revenue plan includes multiple components of a grower’s operation. These include, cost of production, crop insurance, and valuing production.
Once a grower’s operation has been defined, Agyield can precisely show a grower their profitability based on varying yield and price in real time. The AgYield platform allows the grower and the strategist to apply what-if scenarios to show how different transactions affect their profitability. By modeling operational transactions, a grower can make informed decisions. Thinking objectively about their marketing and risk allows producers efficiencies not afforded by opinion based strategies. This approach is fluid, transparent, precise and informative. It removes as much price dependency and speculation as possible.
Jesse Livermore, a great trader, once said, “The market is never wrong, only your perceptions of it are.” Wrong perceptions and opinions can be very costly to growers. It is not mandatory to be bullish or bearish. Prudence is to be operationally specific and understand the profitability outlook of your operation. The path to profitability for the American farmer is to abandon opinion based approaches and embrace a well constructed, flexible revenue plan.
Federal Crop Insurance Decisions 2/15/16
Crop insurance is no doubt the cornerstone of any solid marketing plan. At AgYield and EHedger, we don’t even offer crop insurance, but we still recognize its importance to the grower. It’s not just a backstop to prevent financial catastrophe, it provides the confidence to market bushels while the price is favorable, long before the producer knows his actual yield.
With the crop insurance election deadline approaching, we want to discuss something that is a concern to us this year. We’ve heard stories about growers considering to lower or even eliminate crop insurance coverage in order to save money. We think this could be a mistake…
Besides cost cutting, the main reason for the grower to consider this move is due to the lower spring price guarantees. The average price of corn and beans are currently down about 27 and 85 cents respectively from 2015. The prices are already 50% locked for the month of February, which means there is little chance for these levels to improve by a meaningful amount. In many cases, this will leave producers with a guarantee that may be 100’s of dollars below their actual cost of production. While this is a problem that has to be overcome, it’s not going to get fixed by saving the $10 – $15 on crop insurance premiums. In fact that strategy may backfire if weather turns sour this summer. Crop insurance is needed most when prices are rising from falling production. In that case, the spring price would become irrelevant and the higher fall price would used, just as in 2012.
The following is an example of a corn grower’s profitability for this year. Using the Farm Doc’s cost of production estimate, this grower needs $805 per acre in revenue to breakeven. He has an Actual Production History (APH) of 200 bushels per acre and has nothing sold yet for 2016. Using these attributes, we can see his potential profit/loss outcomes at different yield and price scenarios on the following matrix:
If the year turns out to be low yielding with low prices, its obvious that this producer would be subjected to large losses. While at high yield and high prices, he would turn a large profit. We don’t know how the year is going to turn out because we can’t predict the weather, nobody can. This is of course the reason that insurance is the backbone of the marketing plan.
In years like 2013, crop insurance guarantees were so high that they could literally wipe out the red portions of the matrix, guaranteeing revenue above costs. Today however, is a different story. Producers will need to rely on other forms of marketing throughout the year. To illustrate how the insurance policy can impact marketing decisions, we will compare two different strategies using a sales only marketing approach to achieve a guaranteed break-even matrix.
The 75% policy holder
Using the same producer credentials, the 75% holder has the ability to sell up to 150 bushels per acre without getting “oversold”. To make sure he is above break-even revenue goal at every yield and price level, this producer would have to sell his guaranteed bushels at $5.37. This would result in a profitable year at every price and yield point on the matrix.
85% policy holder
Meanwhile, the 85% holder would be able to to lock break-even at every yield and price level by selling his guaranteed bushels at $4.74. This is lower than the 75% policy holder because he has an extra 20 bushels guaranteed. He can afford to make that sale at a lower price if needed.
Both scenarios reach the same goal, however the 85% policy holder is much more likely to achieve it in the event of a crop problem this summer. The options delta says that $4.74 has about a 19.5% chance of being reached this year, while the $5.37 level has about a 10.4% chance. Last year, the highest the market could get was $4.54 ¼, and that was it! It is important to have a price goal that is more likely to be achieved.
If futures prices are pushing $4.75 – $5.50, there is a higher probability that your farm will actually NEED that insurance this year. These prices would indicate a large supply problem somewhere and it could very well include your farm.
At the end of the day you have to ask yourself “why do I buy crop insurance? Am I trying to ‘bet’ on an insurance payout or am I trying to lower my risk systematically and improve my chances of turning a profit?” HOW you use that crop insurance policy is part of that answer.
Please note that in the examples above, we only used sales to achieve the break-even scenario. There are other ways to improve farm profitability by using tools such as options. Options can provide a greater degree of flexibility in low margin years like this one.
If you would like to compare your insurance policies please get updated cost estimates from your insurance agent and then call your AgYield representative to go over the policy differences. The following is an example of the matrix showing only the insurance policy to compare the payout levels: