It isn’t only agriculture. China has become the world’s largest market for an incredibly long list of commodities. Consider the manufacturing industry, for example, where the Chinese generate roughly half of global demand — they use 54 per cent of global aluminum production, 50 per cent of nickel, 48 per cent of copper and 46 per cent of steel.
It’s no wonder that 2015 has become the year of China, with the whole world watching its financial upheavals, stock market corrections and other gyrations.
As China ratchets its growth down, the result has been lower demand and the emergence of a multi-sectoral bear market in commodities.
Global grain is no exception, says market analyst Errol Anderson. Chinese buyers might represent a smaller market share in these commodities — they’re roughly 20 per cent of global wheat demand, for example — but they’re still significant enough to knock demand down another notch within a market that is already struggling with supply.
This is a sea change after a number of years of buoyant demand from growing economies and the imposition of ethanol mandates for vehicle fuels. That was a secular bull market. This is a secular bear, working its way through the excesses of the bull. That process always takes some time, and the farmer who understands the reality of where the market cycle is will be better positioned to grab profitable pricing opportunities when they appear, which they always do.
On the other hand, Anderson warns, the farmer who hangs on expecting the bull to come roaring back may be disappointed, hanging on and hoping for better prices that never come, and in the end selling for less than if they’d had a plan and stuck to it.
Country Guide: Tell us a bit about the personality of the market right now. What do farmers need to understand in order to make a marketing plan that works?
Errol Anderson: Key trade and economic wars are beginning to develop. There’s a global vegetable oil war going on between soy and palm oil exporters battling for market share, there’s a wheat price war going on between the U.S. and Russia as they battle for market share, and likewise there’s a battle for market share among oil producers. All this is combining to produce a strong undertow for all commodities, which really means we have to keep price expectations in check.
On top of these trade skirmishes, there is also a global currency war ongoing right now. Central bankers continue their rush to print money in an effort to devalue their currencies and make their economies and exports more competitive globally. It’s actually a battle for the bottom. Who can devalue their currency the most?
Demand is everything right now, and it’s not strong. I really think that 2016 is shaping up to be a battleground year. That’s going to keep commodities of all types, including grains, under a lot of price pressure.
CG: More than once I’ve heard you say that falling markets are more predictable than rising markets — now that we’re in one, what should we expect?
EA: That’s really going to be the key thing for farmers to get their heads around right now.
The plain truth is that bear markets always last longer than bulls. Bull markets charge ahead, but you can’t really predict where the peak is going to be — most times you only recognize the peak once it’s past, and when it is past, it can pass quickly and prices can move down even quicker. A bear market, on the other hand, lasts on average twice as long as a bull, and you can see the bottom. Prices typically head down to where they originally came from. You can see this on the charts. It goes down and trades sideways for weeks, at times for months.
That’s where we’re at right now. Commodity prices in general are going to trade sideways to lower for much of 2016 — but I don’t want to say there won’t be opportunities to price grain profitably. There will be, there always are, even in bear markets. But for a farmer the important thing is going to be to understand that we’re in a bear market. Commodity prices can occasionally break higher, but those opportunities will be fleeting. Farm marketers need to be ready to move when the opportunities present themselves. If they’re not, profitable pricing may be missed.
In this new economic environment, believing that bear markets are simply temporary and that higher prices will reassert themselves takes on a much higher degree of risk for the grower. Prices will not be as responsive as global markets work through these economic issues. There will be short-term opportunities — like the weather market we saw in early summer when farmers and traders were concerned about drought. But these events are opportunities to price profits. Production was an unknown making cash contracting a risky business. But there are market tools out there like put options that don’t expose you to delivery commitments. The key heading forward is for the grower to be ready to move on rebounds and profitable pricing opportunities.
Remaining paralyzed while you wait for prices to recover to past levels may be self-defeating. You can really see this occur in any market. It’s a common error whether it’s a real estate investor or a grain producer, and one you can’t afford to make in the current global environment.
CG: Why do market cycles always repeat? Where are we globally in terms of the markets? What are the knowns and unknowns?
EA: Market cycles always repeat because markets are simply made up of people and their emotions. As a result, they are somewhat predictable. We are all human, and markets reflect emotions that swing between fear and greed. This is natural, but it must be respected.
When markets experience a sudden setback, the greed that contributed to the market rise is quickly replaced by hope that prices will recover. Then, as prices continue their descent, these emotions are replaced by fear. And if the drop continues, panic selling can set in, driving prices even lower.
This is natural, but you don’t want to get caught up in it. These emotional market swings directly impact the profitability and success of a business. And 2016 will already be challenging enough in all markets, including global grains.
When assessing commodity markets, we really need to understand what’s affecting economies globally. In a very real way, we’re still working through the after-effects of the global financial crisis of 2008. At the time it was said that we were potentially facing another Depression. But central banks really pulled out all the stops with tools like quantitative easing, which is money printing and lowering interest rates in an attempt to kick-start inflation and the economy.
These strategies served to kick the can down the road. But we’re simply not out of the woods yet, and I really don’t think we’re going to see the Federal Reserve increasing U.S. interest rates for the foreseeable future. There’s simply too much market contagion risk for the Fed to follow through on raising rates — though it’s made the wrong decision in the past, so anything is possible.
What markets are going through right now is eerily similar to 1937, and students of economic history can tell you that was a very significant year when rates were hiked prematurely. This decision choked economic recovery, prolonging the Depression until the outbreak of the Second World War. Right now there really is little inflationary pressure, but increasing deflation risks.
Central bankers really fear deflation because they can’t combat it. Consumers reinforce it by delaying purchases. This can become a deflationary spiral because it feeds on itself forcing prices to drop — a self-fulfilling prophecy.
Right now, we have a lot of unused capacity in electronic manufacturing. And the price of consumer electronics is dropping globally. In fact, the cost of an Apple iPhone, for example, may actually drop over the next year as global competition heats up from Asia.
For a farm in Canada, inputs are impacted by supply and demand and the value of the Canadian dollar. It’s possible some input prices may decline as a result of these deflationary pressures, but we may also need the added push of a gain in the loonie.
CG: You’ve said you think market volatility, especially in a down market, is a good thing. Why is that?
EA: That’s where you find profitable pricing opportunities in these sort of markets. Farmers often fear volatility, and find it stressful, when really they should be embracing it. Without periods of market volatility, they wouldn’t likely have many opportunities to price grain profitably. But it needs a trigger of some sort — weather or political unrest, for example — that causes buyers to become concerned about supply and speculators to buy the market. This can lead to sharply higher prices but often with a short shelf life.
Without volatility, commodity prices would just trade sideways, potentially at unprofitable levels for long periods of time. So when price volatility heats up, farmers should embrace it and plan for it. They should understand what their cost of production is, and have a price that they’ll execute on. Doing this will take a lot of the emotion out of their marketing decisions. And a plan supports their profitability and future goals for their farm business. If price volatility is high, this can generate some attractive profits, particularly during heated weather markets when prices often surge well above their true economic value.
CG: In this sort of environment, what are some of the common marketing mistakes producers make?
EA: There’s a handful of common errors that any marketer should do their best to avoid and to not fall prey to.
There’s seeking the highest price possible, which is an admirable goal but highly unrealistic. What’s much more likely to happen is they’ll hold their grain too long, miss the peak, and ultimately sell into a falling market. Often the price achieved here is less than if they had sold following their marketing plan. Let’s take canola for example. The cash market through the early fall was hovering around $10 per bushel, and an efficient producer might have a cost of production of $7 a bushel — there’s profit there. Within the last couple of years, canola bids have been as high as $14 per bushel. But holding out for higher bids later in the crop year is always a gamble. Given the turndown in economies, chances of canola rallying toward past heights are slim at best. The best decision may be to lock that profit.
There’s also the thinking that if farmers don’t get the price they want, grain should just be stored. This strategy just works once in a while, but the truth is, it could be a long wait. There’s lost opportunity cost not getting needed cash flow, as well as risk of theft and spoilage. They’re assuming a lot of non-price risk by storing grain. And in my mind, they should be planning to market their grain in the same crop year they harvest it.
Another error may be assuming the market owes you a higher price because you got it before. But the truth is, markets today are about what the buyer is willing to pay. In the commodity world, we are now in a demand-driven price structure. And what you sold for last year is meaningless.
During lean times, good managers and marketers distinguish themselves. Marketers who can take emotion out of the decision-making process and conduct business in a clear-eyed fashion set themselves up for success, especially when conditions improve.
CG: You’ve always told me there’s a difference between being a farm speculator and a farm business manager who’s pursuing defined goals.
EA: The most important thing to understand is we have both a speculative and a business side to all of us. It’s just a matter of the degree. It can be really easy to unknowingly blur the lines between the two. We can all get carried away by the emotion of it all — getting too excited, trying to hit a market peak or even increasing business risk by scaling in unneeded long futures positions while the grain remains unpriced.
The things that can really get you into trouble are the lack of a plan, and the inability to price in a rallying market. This can lead to lost opportunity and lost profits. In 2016 we’re going to be looking for a weather market — something that causes the bear cycle to break. A good farm marketer understands weather markets are often a temporary boost. And during this cycle of lower global commodity prices, it’s important to be ready to act when the opportunity allows a cash price to achieve a pricing target.
On the flip side, a farm speculator tends to watch prices in the attempt to hit the peak. The risk there is you can become mesmerized by the market and the daily swings. You’ll watch markets almost obsessively, waiting for the right price to convince yourself to let the crop go, but then fail to act. Without a plan and the discipline to execute it, it’s really easy to become a speculator without knowing it.
A lot of people have this image of a speculator as a wheeler-dealer when in reality it can be all of us, if we’re not careful. Here’s a warning sign. If you price a crop profitably, and the market then goes higher, do you obsess about the money “lost,” rather than acknowledge your plan worked and grain was consistently priced profitably? In reality, a rallying market is an opportunity to look toward pricing new crop production. This offers just another solid business opportunity. It’s all about how you look at markets, and your ability to handle emotion.
This article was originally published as ‘The right price’ in the November 2015 issue of Country Guide.