Market Analyst Mark Gold discusses the commodity markets with host Mark Pearson.
Pearson: This is the Friday, August 5, 2011 version of Market Plus. Thanks for joining us here at our Market to Market web site. Special guest this week joining us in our studios, Mark Gold with Top Third Commodities. Mark, I have heard you speak many times and we could talk about the ups and downs and the volatility that we've had certainly in the commodities markets, not just this week, but really since about September of 2006 when the bull markets started. Getting people to capture profitability has always been an issue and I have heard you speak many times on the whole issue of risk management and we have to have it. Talk a little bit about that. What are you telling people?
Gold: Well, in our opinion when we have such high input costs, land costs, cash rents around the country from three to five hundred dollars an acre and the chemicals and the seed costs and all what people put into it, I believe the American farmer is a manufacturer, and like any manufacturer they are governed by production times price equals revenue. Well the American farmer will spend three, four, five hundred dollars an acre to produce the crop. I would ask them how much they are spending to protect the price of that crop. Well, if you want to maximize the revenue at the other end of the equation I believe you need to spend some money to protect that price side of the equation. Now to me marketing isn't about speculating. I don't want to hear anybody's opinion an analyst, a broker, a newsletter about what they think the market is going to do. In our opinion if anybody knew where these markets were going they wouldn't be telling us. They would be trading this market or long retired.
Pearson: Right. They would be on a boat somewhere.
Gold: Exactly. So what we want to do is look at the risk that is in front of us today. We look at these prices, near historical prices in soybeans, corn, cattle, hogs, milk, and we say I don't know whether these prices are going up or down or not? But I do know that there is a tremendous amount of risk on the table and we want to spend some of that money protecting price by using a put option. We use a put option as an insurance policy to protect the downside. Now the tough part is, just like any insurance policy, you have to pay that premium and in beans maybe it is forty cents a bushel and corn it is twenty-five to thirty-five cents a bushel and you have to spend that money to protect that price to ensure that revenue over time.
Gold: Now the tough part is, like any insurance policy, you want to loose the premium. If you have got life insurance, Mark, you don't want to drop dead tomorrow so your wife can collect on the policy. You want to stay healthy and loose that premium every year. Well it is the same thing. When we buy this put option to protect the downside - today for example at six fifty corn you can buy a, or excuse me it is seven dollar corn, you can buy a six fifty put for twenty-five cents. That puts in a net floor of six twenty-five on your corn. Now you want corn to go to eight or ten dollars a bushel, you are going to loose that twenty-five cents you paid for that insurance policy, but you have the corn to sell at higher prices. If this market falls out of bed from these historically high prices for whatever reason, whether we see it coming more or not, you're protected if corn goes to five dollars, four dollars, let alone back to three. Gold: I believe the American farmer gets caught up in some of this bullish rhetoric that they hear and see about everything and, you know, people know that the American farmer wants to hear the bull side and I'm as bull - I generally made my good money trading on the bull side. But the fact of the matter is when you get in the upper third of historically prices you have to realize that there is risk out there, you have to manage this risk, trying to out trade the guys in Chicago is a loosing proposition. Only seven percent of outside speculators can beat the pros. Now you would say why does anybody want those odds? Well the fact of the matter is on these 2011 crops most farmers haven't sold very much corn or soybeans right now. Which means they're long. Which means they are speculating. What are the odds that they are right? Seven percent.
Gold: So we want to protect that risk. We certainly hope prices go higher for the American farmer but when you are in this top third of historical prices we have to manage that risk to protect the downside.
Pearson: Well said. We talked about volatility this week. I want to just touch a little bit about what you see. You mentioned Dennis Gartman and he has had a lot of fascinating things to say about the market. I know he uses comments from you on a regular basis too. As we look at this thing going forward with the situation in Europe, the situation in the U.S. maybe starting to get control of it. Are we going to see a shift? Are we going to see kind of a break from commodities? You talk a lot about cycles and we've had a very long, sustained, profitable commodity cycle.
Gold: Well, I believe that in any markets the market will adjust, supply and demand still exist, and the basics of economics haven't changed and until they do I still believe that high prices will draw in more and more production, demand will be curbed at higher prices and ultimately we're going lower. People have to realize one of the real critical factors why markets exist and it is not talked about in the textbooks. They say the markets exist to shift the risk which is all true but part of the function of the market is to force out inefficient producers. And the only way you can do that is to get the price under the cost of production. When beans went to sixteen dollars in 2008 everybody said well, we will never see beans under twelve dollars again. We've finally gotten over that hurdle. Let's look for twenty dollar beans. Well where did beans go? Down to seven ninety a bushel back under the cost of production. We were at eight dollar corn. They said well, we're never going to see corn under five dollars again. Well, we went to three dollar corn. So the market no matter how high it gets people around the world, farmers around the world, will react. There is Brazil, China, Europe, Russia, Argentina, Australia all capable of increasing and ramping up production and we know at higher prices as we have always have seen you are going to curb demand. So we want to protect these prices. We want to manage this volatility. We don't want to turn clients into speculators.
Pearson: Mark Gold, always great to have you with us.
Gold: Thanks Mark.
Pearson: We appreciate it. Mark Gold with us this week on Market to Market and of course here on Market Plus. Thanks for joining us. From all of us on Market to Market make sure you check us out on Twitter and of course Facebook and we will talk to you again next week.