Iowa Public Television

 

Using the markets to maximize revenue

posted on April 14, 2000


IN THE EARLY PART OF THE 21st CENTURY, IT IS APPARENT THE GLOBAL ECONOMY IS BEING SHAPED BY THE CONVERGENCE OF A HOST OF BIO- AND INFORMATION-BASED TECHNOLOGIES. TO THOSE IN AGRICULTURE, THE PROMISE IS MORE PROFIT THROUGH A GREATER DIVERSITY OF CROPS AND MARKETS. RETURNS ON FARM OUTPUT COULD GROW, AS FARMERS ADD VALUE TO WHAT THEY PRODUCE BEFORE IT LEAVES THE FARM, OR THROUGH PRODUCTION OF CROPS THAT CONTAIN ATTRIBUTES VALUABLE TO SPECIFIC END-USERS.

HOWEVER, IT'S UNCERTAIN WHETHER PRODUCERS OF TRADITIONAL RAW COMMODITIES WILL SHARE THAT PROSPERITY. INDEED, IT'S BECOMING ALL TOO APPARENT THAT THOSE WHO CHOOSE TO PRODUCE CROPS THAT FEATURE HISTORICALLY THIN PROFIT MARGINS MUST BE READY TO MARKET OUTSIDE THE BOX.

LAST FALL, MARKET TO MARKET PRESENTED THE CONCEPT OF FINANCIAL TILTH - A SERIES OF STRATEGIES DESIGNED TO CAPTURE MORE VALUE FROM RAW COMMODITIES THROUGH THE USE OF FINANCIAL DERIVATIVES. SID SPRECHER EXPLAINS IN THIS UPDATE.

STEVE THOMPSON OF BLAIRSTOWN, IOWA IS A COMMODITY BROKER FOR THE CATTLE FEEDING CO-OP KNOWN AS "BEIF", BLAIRSTOWN EASTERN IOWA FEEDERS. HE IS ALSO A FARMER WHO UTILIZES HIS MARKET SAVVY TO ENHANCE HIS RETURN ON CORN, SOYBEAN, AND LIVESTOCK CROPS.

ONE OF HIS MARKETING TACTICS IS TO SELL A CALL OPTION ON HIS ANTICIPATED GRAIN INVENTORY. HE IS EFFECTIVELY RENTING HIS INVENTORY TO SOMEONE ELSE WHO HOPES TO BENEFIT IF PRICES MOVE HIGHER.

STEVE: "And so selling calls is one thing i've done just to at least pay for pay for storage. It doesn't protect you if the price goes down, but if the price goes down it f does at least pay for holding the inventory for a little bit. "

SELLING CALLS ALLOWS FARMERS LIKE STEVE THOMPSON TO EXTRACT MORE VALUE FROM THEIR CROPS. SUCH TACTICS DO EFFECTIVELY MINIMIZE PRICE RISK, AND IMPROVE RETURNS. BUT FARMERS MUST STILL FINANCE AND PRODUCE A CROP. BUT WHAT IF THEY COULD REDUCE THEIR FINANCIAL MARKET RISK, PRODUCE A CROP AT A LOWER COST, AND NOT INCIDENTALLY NUDGE THE MARKET TOWARD PRICE LEVELS THAT ENCOURAGE FARMERS TO PLANT IN THE SPRING? PERHAPS THEY CAN.

THROUGH FINANCIAL INSTRUMENTS, FUTURES AND OPTIONS FARMERS CAN DEPLOY A STRATEGY OF "FINANCIAL TILTH". THEY CAN GROW A CROP ON PAPER. IN FACT THEY CAN GROW A PAPER CROP AT A FRACTION OF THE COST IT WOULD TAKE TO PRODUCE IT IN THE FIELD.

FOR EXAMPLE IN EARLY 1998 FARMERS MAY WELL HAVE BEEN LOOKING OPTIMISTICALLY BEYOND WINTER'S GLOOM. THE DECEMBER CORN CONTRACT WAS THEN PRICED AROUND $2.80 A BUSHEL. FARMERS COULD HAVE CERTAINLY LOCKED IN THAT PRICE; THEY COULD HAVE ALSO EMBRACED A STRATEGY OF "FINANCIAL TILTH". THEY COULD HAVE SIMULTANEOUSLY SOLD A DEC 98 CORN FUTURES CONTRACT AND PURCHASED A CORN CALL OPTION FOR A PREMIUM OF 23 CENTS. THE FUTURES CONTRACT WOULD GAIN VALUE IF PRICES FELL. THE CALL OPTION WOULD HAVE GAINED VALUE IF PRICES ROSE. USING FUTURES AND OPTIONS MINIMIZES BROKERAGE FEES AND MARGIN DEMANDS.

THE NET EFFECT IS THE FARMER COULD HAVE EFFECTIVELY OWNED A CORN CROP FOR $2.56 3/4 A BUSHEL.. BUT THE PAPER CROP WOULD HAVE BEEN PRODUCED AT A CONSIDERABLY LOWER COST THAN ACTUALLY PLANTING IT

IN FACT BY SPRING PLANTING IN MAY OF 98 THAT PRICE WOULD HAVE LOOKED AWFULLY GOOD. BY THEN DECEMBER CORN FUTURES PRICES HAD FALLEN DRAMATICALLY FROM THE JANUARY LEVEL. PRACTITIONERS OF "FINANCIAL TILTH" WOULD HAVE BEEN ABLE TO SAY NO TO PLANTING A PHYSICAL CORN CROP, HAPPILY EXTRACTED A MODEST MARKET GAIN FROM A CROP NEVER GROWN, AND SAVED THE COST OF PRODUCING IT. FOR THAT MATTER THEY COULD HAVE MAINTAINED THE PAPER POSITION AND ENJOYED A SUBSTANTIAL PROFIT BY LATE SUMMER AND IN THE MEANTIME MAY HAVE EVEN PRODUCED AN ALTERNATIVE CROP LIKE HAY.

IN 1999 A YEAR WHEN GOVERNMENT LOAN DEFICIENCY PAYMENTS WERE LURING FARMERS TO DEVOTE A RECORD NUMBER OF ACRES TO SOYBEANS PRACTITIONERS OF FINANCIAL TILTH COULD HAVE LOCKED IN GAINS OF MORE THAN 50 CENTS A BUSHEL BY PLANTING TIME. NO DOUBT HAD THEY CHOSEN TO CONTINUE TO PLANT THEY WOULD HAVE ENJOYED THE LARGESS OF THE GOVERNMENT'S "LOAN DEFICIENCY" PROGRAM.

WHILE CAUTIOUS ABOUT FINANCIAL TITLH IOWA STATE UNIVERSITY ECONOMIST ROBERT WISNER CAN IDENTIFY OPPORTUNITIES FOR ITS DEPLOYMENT.

WISNER: "if you are paying a very high cash rent for example, you would have the alternative of not renting that land and not losing money on it. This may be an alternative for people to look at. If you've got owned land that you can rent out to someone else. Let them take the risk and then use a portion of that money in this way. Again may be a possibility. It takes ... it takes some special skills that a lot of people don't have, but there are people out there who have those skills. And it could make perhaps very good use of this kind of alternative."

LIKE PROFESSOR WISNER, STEVE THOMPSON IS CAUTIOUS, IF NOT SKEPTICAL, ABOUT FINANCIAL TITLH. BUT HE TOO CAN SEE OPPORTUNITIES TO USE IT.

Steve: "I think probably some acres out there where it might make some sense that you could look at ... that don't produce well. You know the land that's producing 180 bushel an acre, is going to be hard to let that sit idle, but it you got a wet land or ...or something where it's in a corner that's only producing you know 80 bushel well then that's something that you should leave off and not plant.

THERE ARE SOME OTHER ADVANTAGES TO FINANCIAL TILTH. ALL TOO OFTEN THE NATURAL DISASTER THAT DRIVES PRICES HIGHER ALSO CLAIMS THE CROP. A PAPER CROP IS INVULNERABLE TO NATURAL DISASTERS, DISEASE, AND PESTILENCE. HOWEVER FARMERS COULD USE CROP REVENUE ASSURANCE POLLICIES THAT GUARANTEE THEM A MINIMUM NUMBER OF BUSHELS AT HARVEST. SUCH POLICIES SAYS PROFESSOR WISNER ALLOW FARMERS TO FORWARD PRICE A GREATER PORTION OF THEIR CROP AT THE MOST PROFITABLE TIME.

Wisner: "If you look back for instance ah it is hard to believe that November beans current November we've had a high of 6.80 per bushel very well above current prices during the winter and spring."

BUT THERE IS NO INSURANCE POLICY AGAINST ANOTHER FINANCIAL PREDATOR.

ANOTHER BENEFIT OF FINANCIAL TILTH IS A PAPER CROP IS NOT VULNERABLE TO "BASIS" THAT IS THE VERY REAL PRICE DIFFERENCE BETWEEN QUOTES ON THE GLOBALLY TRADED BOARD OF TRADE AND LOCAL COUNTRY ELEVATORS. LIKE MARKET PRICES "BASIS" CAN FLUCTUATE. A PAPER CROP REMOVES ONE MORE VARIABLE WITH WHICH PRODUCERS OF A PHYSICAL CROP MUST CONTEND. IT BUYS TIME FOR FARMERS, TIME TO DETERMINE WHETHER IT'S WORTH THE EXPENSE AND RISK OF ACTUALLY PRODUCING A CROP. AND NOT INCIDENTALLY, FINANCIAL TILTH T INJECTS A LITTLE MYSTERY INTO THE MARKETPLACE. WILL FARMERS CHOOSE TO PRODUCE A CROP THIS YEAR?

IN FACT IN SOME YEARS WHEN PRICES FOR NEXT YEAR'S CROP ARE DISCOURAGING, FARMERS MIGHT STILL FIND OPPORTUNITY. FOR EXAMPLE IN JANUARY FARMERS COULD HAVE BOUGHT A DECEMBER 2000 CALL OPTION FOR AROUND 20 CENTS. AS IT TURNS OUT THOSE WHO DID COULD BE POCKETING A 20 CENT GAIN AS SPRING PLANTING NEARS, AND COULD THEN EVEN DEPLOY STEVE THOMPSON'S STRATEGY OF WRITING A CALL OPTION AGAINST THE ANTICIPATED INVENTORY, EXTRACTING ANOTHER 30 TO 40 CENTS FROM THE NEW CROP.

IN THE WORST CASE SCENARIO THE CALL OPTION WOULD EXPIRE WORTHLESS - AT A COST FAR LESS EXPENSIVE THAN ACTUALLY PRODUCING A CROP. BUT THE STRATEGY STILL OFFERS FARMERS WHO CHOOSE NOT TO PLANT THE POTENTIAL FOR PROFIT SHOULD GRAIN OR OILSEED PRICES MOVE HIGHER.

IN ANY EVENT A GLANCE AT HISTORIC PRICE PATTERNS SHOWS THAT MOST MARKET OPPORTUNITIES OCCUR PRIOR TO PLANTING. IT IS CRITICAL THAT FARMERS SEIZE THESE OPPORTUNITIES WHENEVER THEY ARISE. BECAUSE IN A WORLD WHERE KNOWLEDGE EQUALS OWNERSHIP THE ONE HOLDING THE CROP AS A RAW COMMODITY THE LONGEST COULD WELL BE LEFT HOLDING THE BAG.

FOR MARKET TO MARKET. I'M SID SPRECHER.


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