“Completely unprecedented,” is how Kevin Tink sums it up. “We’ve got a Canadian dollar that continues to bounce around parity, and the commodity prices are strong in virtually every category, even live cattle prices.”
Tink is senior vice-president with Ritchie Brothers Auctioneers, and you’d think with surging commodity incomes and the new buying power of the Canadian dollar, Canada’s farmers would be (and should be) bidding serious dollars on farm equipment, shoring up their technological competitiveness.
In real life, the story is much more complicated. Once understood, however, it offers powerful insights into what to expect at different points in economic cycles.
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The law of one price
In Canada, our grains and oilseeds are effectively priced in U.S. dollars. That isn’t a big surprise. In 2006, after all, 59 per cent of all Canadian agrifood exports were shipped south of the border. And besides that, U.S. crops have a huge presence in global markets, meaning they establish price parameters even where they aren’t traded.
Because of that, the full effects of the exchange rate are felt every time most Canadian farmers make a sale.
Additionally, inputs such as farm machinery, fertilizer and fuel flow across the border duty free. That’s a critical backstop. With the border being more or less open on so many ag commodoties, if one country had a higher or lower cost of production because of tariffs on inputs, they’d have a huge competitive advantage — or disadvantage.
In the case of our competitiveness with the U.S., it’s particularly important because the U.S. supplied 55 per cent of the merchandise imported by and for Canada’s farmers in 2006.
So far, the numbers seem to align with economic theory. Indeed, the law of one price (LOP) says that when there’s free trade, the traded commodity prices in two countries will be the same, with the exchange rate levelling out input and output costs in each country.
In other words, in book-perfect economics, input prices — including machinery — would reflect the difference in exchange rate.
University of Saskatchewan economists Richard Gray and Mohammad Shakeri have put that to the test. They examined how exchange rates affected prices of major Canadian tradable farm outputs and inputs from 1995 to 2007, and they concluded that a high exchange rate significantly impacts net returns… but not always positively.
Gray and Shakeri pointed to factors like lack of market power, trade restrictions, inventory pricing decisions, price pooling, and transaction costs that can get in the way of exchange rate pass through (ERPT).
In their regression models for farm machinery, in fact, the pass-through of the exchange rate benefits was generally low and time-lagged. Gray and Shakeri chalked it up to farmers buying locally because of the service available in the event of a breakdown.
In other words, local supply and demand pricing trumped LOP economics.
Reality 2010
As the Canadian dollar moved to par and above since last fall, the theories of LOP and the effect of exchange rate pass-through (ERPT) have gotten a chance to meet the real world in dealerships and auction sales across Canada’s farm country.
Here’s the theory. In the last year, as the Canadian dollar exchange rate moved from US$0.94 to above par, the in-Canada price of freely traded inputs should have fallen by six per cent.
Did the theory pan out? Generally, the answer is yes, at least for new equipment where, despite variations between different machinery categories, the overall trend was toward lower prices.
“There’s been a positive impact on the new equipment price and price of parts because of the Canadian dollar value increase,” says John Schmeiser, executive vice-president of the Canada West Equipment Dealers Association.
In Ontario, the new price picture was similar. Keith Stoltz of Stoltz Sales and Service, with dealerships in Elmira, Listowel and Mildmay, says the price of new equipment has decreased in Ontario due to exchange rate issues and he’s sure the cost of parts has dropped too. “In my dealership over the last 18 months, my parts prices have been dropping,” says Stoltz, who also serves as chair of the Canada East Equipment Dealers’ Association.
However, local supply and demand are more significant in the used market, where geography and the seasonality of auction sales have more influence on prices.
While in a perfect economy we’d see a softening of used prices, other factors are coming into play, says Ritchie’s Tink. “Supply and demand is such, and we’ve had quite an increase in (commodity) prices throughout the last few years, it has eroded the gains on the dollar.”
Also important are the trade-in prices that dealers agreed to on deals they made last year. With relatively thin margins at the best of times, and with a big inventory of used equipment, there’s a lot of resistance to chopping prices. “It’s safe to say they were making combine deals that are more lopsided than they had anticipated them to be,” says Tink.
Manufacturers might have to pitch in, says Stoltz. “I would speculate that some of the manufacturers will provide sales allowances to the dealer to help sell inventory which is being affected negatively due to the exchange rate.”
That just builds in more price resistance, because now it’s both the dealers and the manufacturers who will lose out if the used price starts to sink.
In fact, some manufacturers are seeing this as a chance to cut future risks, and they’ve started charging their dealers U.S. prices, which means the dealer takes the risk on exchange differences.
Demand
Besides, the loonie’s effect may simply be getting swamped by other market forces, especially farm optimism. Deals are getting inked because net revenues and the futures prices are so strong. Along with high commodity prices (as I write this we have a 30-year high for corn), the demand side of the equation is getting a kick too from low interest rates. And then there’s the limited supply.
Going into the spring auctions, Tink predicts that strong demand for lower-hour used equipment will bump up prices. (That said, used equipment markets are more localized and it pays to watch nearby sales. Regional factors such as weather problems can have a bigger influence on used than on new equipment prices, as can sectoral issues, such as calf prices.)
Last year’s wet weather in the West has dampened demand in some regions. “Quite a few areas were too wet to harvest last year, so many of those producers suffered substantially and those folks are not going to be stepping out and buying new gear at this point in time,” says Tink.
However, overall in Western Canada, demand remains strong for larger front-wheel assist tractors, combines and high-clearance sprayers, says Tink. Smaller used tractors, not so much.
In Ontario, after a year of high yields and strong prices, equipment dealers are smiling. “Strong commodity prices help overall sales,” Stoltz says, and then adds, “I do not believe the exchange rate had anything to do with it.”
Overall the members of his group haven’t experienced a change in the ratio of new to used sales volume. “Sales of new and used are still very strong in Ontario due to our mixed agricultural base,” says Stoltz.
Supply complicates everything
Although Canadian purchasing power has increased significantly, supplies seem limited this winter. For proof, just ask anyone who’s trying to buy a corn planter. Canadian farmers haven’t felt the full benefit of a higher exchange rate yet compared to if supplies were more normalized.
The manufacturers are driving a change in how inventory is being managed at dealerships. Dealers now often require orders six months in advance. For the larger, more corporate farms, pre-ordering much in advance works well with their set machinery strategies.
This change in inventory management has created a time lag overall and the amount of equipment on-site has shrunk. Additionally, there’s the recent consolidation of dealerships.
Although some dealers want to move inventory, particularly third-or fourth-tier trades, the real supply of the good used isn’t plentiful. “We’re going to see strong used equipment prices in certain categories in the Canadian marketplace, simply because of supply,” says Tink.
The Canadian used auction marketplace has only two small purchasing windows — in the spring and fall — so the exchange rate doesn’t play as much of a role. “The seasonality and regionality of the auction market means that supply and demand have larger effects on sales than exchange rates, says Tink.
Most manufacturers react very quickly to U.S. exchange differences, adjusting exchange allowances a couple of times per month. “Exchange rate adjustments come very quickly now when the dollar is changing,” say Stoltz. “We depend on the manufacturer reacting quickly with price adjustments once or twice a month for parts and equipment.”
“Our industry has learned to live with the fluctuating dollar and knows how to react quickly,” says Stoltz. “Are we perfect? No. Have we come a long way in 10 years? Yes.”
Cross-border shopping
There is always cross-border equipment shopping, but equipment dealers have yet to see n a large increase.
“There will be a lot of Canadians considering shopping across the border,” agrees Tink. “But I’m not confident we’ll see a lot of movement of equipment over the border.” He says internal demand within the U.S. is limiting supply. Besides, not all regions have equipment that fits Canadian production systems.
Although there are no duties on farm equipment, the economics of cross-border shopping depends on freight and prices. If you can organize a backhaul it can be worth it, depending on the speciality of hauling, and where you farm.
However, logistics haven’t stopped farmers from looking. Ritchie’s has seen a higher level of participation from the online sales portion of their business. With the many farm equipment websites, and the loonie flying just over par this winter, many Canadian farmers may be looking south of the border. Says Tink: “With the strength of the Canadian dollar, the used guys are likely scouring what’s out there and evaluating the U.S. market.”CG