The difference between success and failure in business is how well that business is able to manage risk. This special issue of The Progressive Farmer provides ideas for managing risk in one of the most volatile times ever in agriculture.

Have Crop Prices Bottomed Out?
Markets offer clues that proven strategies may be back.
By Darin Newsom

When I sat down to write this story, I intended to talk about how vastly times have changed in grain marketing—how the volatility has altered the way producers and end-users alike use their price risk management practices to accommodate the dramatic evolution of the markets into a wild, investment-driven free-for-all.

But then I realized that maybe I was being a bit overdramatic.

Those of you familiar with DTN's Market Strategies know that I base my price forecasts and DTN's recommendations on six easily identifiable factors: 1) market direction (trend), 2) noncommercial (speculative) position, 3) futures spreads (for underlying fundamentals), 4) seasonal indexes, 5) price probability (historic price range) and 6) volatility (speed of change in the market). These six factors haven't changed much over the past few years.

As a result, the types of strategies used to protect against adverse price moves haven't changed that much either. Don't get me wrong. With the market's higher volatility (factor six), timing is more difficult, hedging in the futures market is riskier and option premiums are more expensive. These developments seem to make the argument that the markets have changed to the point that proven price risk management strategies no longer provide adequate protection.

I will concede that argument to a point. Yet for every futures or option strategy there is a corresponding cash strategy that provides the same protection. But without the risk associated with futures and sometimes at a lower cost than high-priced option premiums. So the more things change, the more they stay the same.

Corn provides clues. One of the most common queries I got from producers this past year is how to market corn in 2009 and beyond with the "demand destruction" that has occurred in the market. The recent drop below $4 in the front-month contract means many producers will be growing the 2009 crop for a loss when input costs and farm rent are factored in.

Let's start at the beginning. The corn market has been in a solid downtrend since July 2008. That downtrend has seen the December contract plummet from almost $8 to a low (as of this writing) of almost $3.80 in mid-November.

But other than the degree—again due to higher volatility—is that type of move unusual? No. A quick look at the seasonal index shows the market normally trends lower from late June/early July before posting a low during fall harvest.

The phrase "demand destruction" rankles me. If demand was indeed disappearing, the markets should be returning to previously established price ranges. Outside of wheat, grains continue to trade well above their historic price ranges and are moving normally within the newly established demand market price ranges.

Last summer's rally in corn to near $6.50 in the December futures contract began to shut down commercial demand as evidenced by the strengthening of the carry in the futures spreads. The subsequent rally to almost $8 was due to the short-supply scare created by spring and summer floods.

Once the floodwaters receded, the markets slid back to near $3.70, a price that falls in the lower 10% of the newly established price range­, roughly between $3.50 and $6.50. (This wide price range indicates volatility isn't leaving in 2009.)

Return to normal. In other words, the market is beginning to show normal behavior to both seasonality and price probability, though at much higher levels due to the demand-driven market. Producers and end users can use these tendencies to establish price risk management strategies just as they always have, but at much higher price levels.

You almost could begin using the futures markets as hedging tools again, though you may be reluctant to jump in after the recent pain of margin calls. But cash strategies implemented at appropriate times (seasonality) and price (probability) will offer the same type of protection and provide the same general opportunities.

Also remember that the 2008 Wall Street washout may make non-commercial traders more reluctant to come charging back into commodities, allowing grain futures and cash markets to begin working in tandem again.

Markets tend to work out their problems in the long run. What we're left with are the same price risk management strategies to deal with markets trading at higher, yet much more volatile levels. And while this may make us adjust our thinking slightly, the same underlying principles apply when it comes to employing a specific strategy.