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2003
Table of Contents |
For ten years prior to 1992, I worked as a corporate financier on Wall Street, Chicago and Europe. The most interesting part of this work was figuring out how and why businesses were successful.
When I returned to the family farm, I noticed that to my previous clients marketing meant product development, brand management and advertising. To a farmer, marketing meant choosing a price to sell. This made me question whether it was as important to spend a lot of my time on selecting a price for my crop sales as it might be to find ways to lower my cost of production and expand my output. With a little poor luck you can spend much time in vain trying to pick a market top when you could be otherwise doing something that would lower costs or boost revenue.
In the commodity corn and soybean production business, the theory I adopted was to accept the grain market’s average price as a minimum and focus on being a low cost producer. I do this by making measured modest sales throughout the year, and reroute the time and energy otherwise spent on price forecasting to producing more crop at a lower cost per bushel.
This strategy does not differ much from the corporate clients I serviced as a financier. Consumer products companies sought to develop a brand image for their products so they could increase sales volume, just so long as their cost of goods sold exceeded manufacturing costs. Once commodity or wholesale product companies covered production costs, they would then focus on minimizing costs to boost their bottom line. Finally, financial institutions also adopt this cost reduction strategy. Banks might take money in at 4% and lend it out at 6%. After that, they would simply look to be as cost efficient as possible to maximize profits. They work on margin and do not speculate on interest rates to make money like a farmer might speculate on grain prices!
Simply put, I sell my crop like a mutual fund company might advise you to invest in the equity market; a little bit at a time. I sell a small amount of my crop weekly throughout the year, and focus my time on operational efficiencies! Meanwhile, most others farmers seem produce grain at the industry average cost of production and hope for above average prices.
I sell my corn and soybean
crop incrementally over an eighty-week interval. Half of my crop is sold in
advance of harvest and half of the crop is sold after harvest.
With 104 weeks in two years, why are 24 weeks excluded so that sales are just
over an 80-week period? I believe that I can improve my sales price slightly
over the straight annual average by not selling during six weeks at harvest
when prices traditionally bottom, for three weeks at year end when too many
tax-motivated sales are being made, and another three weeks around March 1st,
which for a corn/soy farm is when what I call the “John Deere low”
occurs. On March 1st, lots of equipment and land payments are due, so there
is plenty of selling pressure.
Selling one 80th of the crop per week does not necessarily mean that for forty weeks I sell new crop forward contracts and then take a truckload out of the bin for the forty weeks after harvest. I still have access to all the grain merchandising tools. A sale might indeed be a cash grain sale, but it may be the purchase of a put option. It may be the sale of futures contract so that I can take advantage of tighter basis at a future time or the carry in the market. When “push bids” are available, I might move more than a week’s worth of cash grain or forward contracts and I might lighten the position with a repurchase in the futures market.
This raises a compelling question, if you’re going to this much effort to merchandise grain, why not just hire a marketing advisor and increase your revenue? Because the odds are that marketing advisor can’t beat the market! For some reason, Farmers and Internet Day Traders seem to be the only people who believe that you can consistently beat the average market price with widely traded public news!
I employ two strategies to sell grain that Wall Street money managers use to invest funds. The first is Dollar Cost Averaging. This is a fancy way to say incrementally and in consistent amounts. The second is without regard to the price at the time of sale, something known as Random Walk Theory.
Random walk says that prices simply can’t be predicted. Why? Because each day, all available information regarding a widely traded market (i.e. the grain market) is bid into the price. Hence, only new and unanticipated information will move prices higher or lower.
Random Walk theory also holds forward that all markets will reach equilibrium at a price where the number of buyers equals the number of sellers. This is particularly easy to see in the futures market where you can observe shorts and longs. Prices move up or down so as that the number of buyers stays exactly equal with the number of sellers.
If you accept the Random Walk theories that prices can’t be predicted and that markets are already at equilibrium because all known information is factored in, this makes prices just as likely to go up as down in the future!
Then, consider that even if new information is factored in the market, it is only relevant to expectations. Therefore, “good news” may not always move the market higher. For example, if export sales of wheat are 50 million bushels, the market may move lower if the trade was expecting 100 million bushels of sales.
The sum of all these theories are that prices are totally unpredictable and any price movements are just a “Random Walk.” Price forecasts simply for the purposes of pricing grain just create work without a guaranteed payoff, or for that matter, may accidentally reduce the sale price of grain.
One final note. Although I use the Random Walk theory to price grain as I incrementally sell my crop, I still must make some sort of price predictions for enterprise and capital budgeting. To accomplish this, I use traditional fundamental and technical analysis.
 Contact
us: Hans Kok, (208)885-5971
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