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Hold on tight. The global economy is a mess

Not even Errol Anderson knows where the pieces will all fall. What’s a farmer to do?

Buckle up. Commodity markets look to be in for a wild ride.

China is experiencing its first major setback since its market liberalization began. It generated 40 per cent of global economic growth last year, so this is troubling. If its engine is faltering, everyone is going to feel it.

Market analyst Errol Anderson tells us commodities are likely to be among the hardest hit because they’ve been among the biggest beneficiaries of China’s growth. Iron ore, copper, steel, coal, grains… all these building blocks of a modern society have been in high demand, translating into investments that have grown supply.

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With demand dropping, the future is unclear. Anderson says he doesn’t want to be an alarmist, but he’s cautioning producers to do what they can to protect themselves. There will be opportunities for good marketers, but they’ll be fleeting.

Country Guide: What’s actually happening in China?

Errol Anderson: You just have to look at the actions of the Chinese government. They’re clearly very concerned about the slowing economic growth across China that has been occurring for the past two years. In mid-August, they devalued their currency three times in a single week. This is a historic move. They’re doing everything they can to keep their factories going, to keep their exports moving and keep their people employed. And this may be just the beginning. It may take several years of economic restructuring that will heighten market uncertainty for producers, exporters and manufacturers. This situation will definitely impact global commodity markets.

The actions of the Chinese government could set the stage for the threat of a trade war. We’re already in the midst of a global currency war, though central bankers certainly don’t want to say those words.

It’s called stimulus by the central bankers. It’s excessive money printing and a race for the bottom in currency markets. Every country wants a cheap currency to kick-start their exports and drive demand for factories and jobs. It’s happening right now. Global currencies are being devalued around the world, and the U.S. dollar has strengthened because of that.

But even the U.S. is starting to feel the effects of increased global competition. Its manufacturing sector is under real pressure.

In China, they’re basically getting an education now on the volatility and economic swings of capitalism. They’ve experienced the good parts over the past 25 years or so with dramatic growth and creation of wealth. Now they’re experiencing a setback, and it’s going to affect a lot of things including how they do business. It’s going to be very interesting to watch. Essentially what you have in China is a controlling government that is seeing a taste for free enterprise among its people. It’s a situation that is a bit perplexing and even frightening for them. Certainly these are uncharted waters.

CG: What is this going to mean to a Canadian farmer?

EA: Demand is king of commodity markets once again, not supply, and that’s going to require a new attitude towards marketing for Canada’s farms. If you go into this new economic reality believing a market owes you something and that profits are always part of the game, it’s not going to work out very well for you.

You might say, “I got $13 per bushel for my canola last year, and I want it again this year.” With that attitude, you might miss selling canola profitably at $12.

Selling your cash grain into a falling market can be like chasing a rabbit. Falling markets often move very quickly, and you miss a solid profitable opportunity, so you may end up selling that canola at $8 or $9 per bushel.

Canadian farmers tend to focus on the supply side. Our weather conditions affect local supplies, but they don’t move a global market much. And often farmers fail to understand this disconnect. Also, commodity markets in general are feeling the pressures of global deflation, and in a deflationary environment, demand is king of price direction.

This is a giant economic cycle, and it could take a while, maybe a few years, before economies regenerate and rebalance the law of supply and demand. But for now, deflationary pressures have taken control of the commodity world.

This is a fairly substantial change in market mindset after the past few buoyant years in farming. But it is an unavoidable situation tied to the big-picture global economic cycle. I have some solid economic contacts in places like Malaysia. They all expect the commodity price meltdown and deflationary pressures right now will take some time to work through, perhaps two to three years of a soft patch.

I don’t want to sound all doom and gloom or like it’s hopeless, but this is the reality markets are now working under, in my opinion. As a producer, you want to be prepared for it and be able to move decisively when opportunities appear. The profit door will open. But it may slam right back shut. You’ll need to be ready and have a plan in place.

CG: What are the implications for a farmer planning a marketing strategy for this year?

EA: You’ve heard this before, but growers need a plan. A plan is essential to keep egos and emotions out of the decision-making process. Know your cost of production, know what a profitable price is, and be ready to take it when it presents itself.

Back in my days with Alberta Agriculture, our focus was promoting the concept of trying to market in the top third of prices every year. Now that might sound a bit esoteric — what’s the top third, after all? But what was really said is that growers should aim to sell for a profit, rather than trying to hit the peak of the market. Over the years, I’ve seen a lot of people try pricing at the top of markets, but few succeed. It’s really hard to predict the top of any market, and most times you only see it in the rear-view mirror. The most likely outcome is that you’ll pass over opportunities for profit and wind up selling into a falling market. And the end result is less income than if you’d made a plan, been disciplined and stuck with it.

Think about it in terms of baseball. Everyone loves to see a home run. It’s exciting, the fans roar, the player runs around the bases, there’s a big celebration at home plate — that can be pretty heady. Hitting the top of the market is a lot like that — exciting and a bit seductive. But the funny thing is that home runs won’t necessarily contribute to the team getting to the World Series. What makes that possible is consistency. Reliably getting on base, hitting singles and doubles, game after game after game, throughout the year. I think marketing is the same, and more farmers should think about taking a “Moneyball” approach, if you’re familiar with that concept from the book and film, where you build a winning team around journeyman players, not stars.

Growers need to start their marketing plan well ahead of the combine — months ahead — and scan for those pricing opportunities. If you see an attractive futures price or basis, you can lock that in. I would start small and scale up.

Then closer to harvest, when a grower has got a clearer idea of what actual production may be, forward pricing can become more aggressive. Of course there’s the issue of production risk. This is where a commodity trading account can add horsepower to a marketing plan. Put options allow you to lock in a futures selling price for a predetermined premium and in that way act as a price insurance program that you manage yourself. There are no predetermined rules, which are the downside of government support programs. Put options offer growers a lot of flexibility in a marketing plan. This tool offers price protection without production or delivery obligation. But you’ve got to understand them as insurance.

Some farmers understand this strategy, others don’t.

CG: You’ve occasionally mentioned “managing” basis contracts — can you explain that a bit more clearly?

EA: Basis contracts are very valuable tools, but they have some drawbacks, and perhaps the most crucial one is that they can encourage procrastination, because procrastination can be deadly, costing a grower both money and time. And if basis contracts are not managed, pricing opportunities can be missed. Also, holding a basis contract too long may eventually force a grower to consider rolling these contracts forward into another futures month. A roll adds time, but does cost the grower some money.

I am really not a fan of incurring the expense of rolling basis contracts. There are other options you can use at this point, and I do suggest them to my clients — strategies like pricing the contract and buying a call option to replace cash grain sales. These calls will increase in value should the futures increase. And they are a lot less risky than storing grain unpriced in the bin.

The bottom line for dealing with basis contracts in my opinion is: don’t roll them into another month. Enter into them with the intention of executing them and pricing them during the term of the contract. You really want to get in and out within a reasonable time frame and not leave them lingering. Have a target price in mind and then execute them.

If you are still bullish, use other tools in your marketing tool box to reopen your cash price ceiling. If you don’t, you’re going to fall victim to procrastination, incur fees and potentially sell into a falling market — sort of a death of a thousand cuts.

CG: It’s easy to say “wait for profitable opportunities to price grain” but as we’ve discussed in the past, oftentimes there are bills coming due and other imperatives. How can a farmer reconcile the two?

EA: This really speaks to the importance of knowing and using your farm financial situation to set marketing objectives.

Yes, there are going to be times when you need cash flow to meet debt obligations, but that doesn’t mean you have to panic sell. You can plan for these needs. You’ll know when a bill is coming due or  when you have to make a machinery or land payment, and you can schedule sales for these, perhaps using some of the available tools from your local grain buyers.

For example, should you see an attractive rally through spring or summer, this would be an opportunity to sign a deferred delivery contract, especially if fall basis levels appear attractive. And if you sign a deferred delivery contract, you are also effectively reserving space for new crop delivery. And this ensures that the grain delivered early fall is done at profitable levels. This gives you timely cash flow to meet those fall bill payments. And if you are still bullish and want to reopen your price ceiling into the winter market, this may be time to purchase call options to replace your fall cash sales.

This strategy injects cash flow at profitable levels, and if you want to speculate on even higher prices, there are strategies in your marketing tool box that can be utilized through your commodity trading account.

But if you are caught selling off-combine to meet financial commitments, this is really marketing by default. I hate it when that happens — absolutely hate it — because then you’ve lost control.

CG: What are some of the things that can derail pricing objectives? What can growers do to stay on top of these issues?

EA: Having unrealistic price expectations is a definite problem. It’s like believing the market owes you a certain price when the hard truth is global buyers don’t care about costs. That’s a tough one. But you just have to take one look at other commodities like crude oil, or coal or copper production or coffee to see how this plays out.

Buyers of commodities do not care about production costs. Letting your feelings and ego get involved prevents you from making good, sound business decisions. You need to understand that markets will change, and you need to change with them.

The biggest unknown that none of us can predict is how the current global economic situation will play out. It has definitely slashed commodity prices worldwide. In one way, we in the grain sector actually have a slight advantage in that we’re playing an outdoor sport — by that I mean a lot of things can affect supply or at least the perception of supply, and this is where we will trigger pricing opportunities through fund-related buying rallies in the futures. Compare that to a commodity like coal or steel, where there are far fewer production disruptions, and therefore during periods like these, fewer opportunities to price for profit. Everyone in this industry will certainly be watching how things unfold with great interest over the next few months. Our next discussion in a few weeks could be an interesting one — there will be lots to talk about.

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