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Global economy influences local commodities

By Mark Parker

Like a thunderstorm rolling across the agricultural economic landscape, commodity volatility rains down opportunity as well as challenge. And in a farm financial climate that’s growing more complex, managing that uncertainty is the key to profitability.

According to Frontier Farm Credit Chief Financial Officer Tony English, outside macro-economic drivers are increasingly shaping commodity price movements — those of both farm crops and the inputs required to produce those crops. In addition to market fundamentals, currency markets, emerging economies around the world and the flight of investment capital into commodity indices have more impact than ever on the prices farmers receive, as well as, the prices they pay.

“Like it or not, the whole concept of a global economy is on us,” English says. “Not only do supply and demand contribute to volatility, but a growing number of factors interact to create price movement.”

English points out that increased demand from emerging economies — particularly in Asia — is combining with a weaker dollar to help drive commodity prices higher. When the Chinese central bank raised its rates on December 13, for example, English noted an immediate downward pressure on the dollar as investors moved to more attractive rates of return. On the supply and demand side, emerging economies appear to be rebounding more quickly from the global financial crisis, further supporting demand for farm commodities. China already accounts for 60 percent of global soybean imports and, along with Brazil and India, has increased its demand for wheat the past two seasons while wheat demand actually decreased in the U.S. and the European Union.

Tom Leffler, who runs Leffler Commodities at Augusta, Kansas, says English is right on track about increasing price volatility. “If you watch the market on a daily basis, it’ll drive you crazy,” he says. “The market moves more and moves quicker than ever before. We have a market that’s not being traded strictly off the fundamentals and we really need to understand that out in farm country. The value of the dollar is a double-edged sword in the market and we have these funds with a tendency to move large amounts of money into and out of the commodity market. Not everything is predictable so you have to position yourself for volatility.”

Across the board, farm commodities are trading substantially higher than a year ago, Leffler notes. Corn, soybeans, wheat — all went into 2011 two to three dollars higher than their value at the beginning of 2010. And the story is pretty much the same in the animal protein markets with many predicting even loftier cattle prices ahead.

It’s enough to get any farmer excited but it’s also a situation that gives Leffler pause. “Somewhere down the road, we will see a real train wreck. For beef, corn, wheat and other commodities, we can get to the point where high prices impact usage — buyers will back off and either seek alternatives or cut back on use. That will put downward pressure on the markets. Remember, as recently as 2006, corn was trading in the $2 range and soybeans were around $5 and two years later we saw record highs. I don’t see us retreating to 2006 levels anytime soon but I don’t see us holding at current prices forever either. And regardless of the longer-term trend, we can see fairly large movement both up and down from one day to the next.”

“For a farmer,” he continues, “the important thing is to take advantage of high prices when you can and protectyourself from the lower prices we will have somewhere down the road.”

English adds that today’s agricultural producer needs to have a balanced risk management strategy. “We have to remember that volatility affects our inputs as well as our outputs,” he notes. “Crude oil prices move in a global economy but they obviously have a tremendous local impact on a farmer’s cost for diesel, fertilizer and a wide range of petroleum-based products. At the end of the day, we can’t just do a good job of marketing our output. That’s just one side of the equation. We have to be balanced. We have to consider what’s going on with commodities that affect our costs.”

Cash rent — particularly on a multi-year basis — is another area in which volatility can wreak havoc with farm finances. Obviously, bidding up rent when crop prices are high can leave producers financially vulnerable when those prices fall. According to Kansas State University Extension Agricultural Economist Kevin Dhuyvetter, land rent is yet another area that requires risk management.

“With today’s magnitude of volatility, in a situation where a fixed cash rent is negotiated for a three- or five-year period, someone is going to be wrong during that period — someone is going to be unhappy,” he says. “For example, a cash rent of $60 may have seemed reasonable when it was negotiated but, with today’s prices, that same land may rent closer to $100. And of course that ‘fair’ price can move in either direction. We really need to start getting more creative in dealing with volatility.”

Flexible cash rent leases can be an effective means of addressing the issue, Dhuyvetter says. “One way people have done this is to simply pay a bonus on top of the negotiated rental rate when prices are favorable,” he notes. “They have the right idea but that’s somewhat arbitrary. A bonus tends to become expected. I think it’s important to tie flexible cash rent to a formula that responds in a predictable way to what’s happening in the market.”

The sharper ups and downs of the market make it more important than ever for producers to have strong relationships with the people linked to their operations.

“A very important aspect of dealing with volatility,” Dhuyvetter asserts, “is to increase the level of communication with all parties, particularly input suppliers, lenders and landlords. The better everyone understands the situation, the better they can work together.”

Keeping one eye on the global economy while juggling the demands of an individual farming operation is a lot for any farmer to have on his or her plate. Just as commodity prices reflect more complex causative factors, managing them requires a more intensive financial strategy.

“It takes a team,” English says. “One person cannot be an expert on all things and even if he or she were, there aren’t enough hours in the day. That’s why our approach at Frontier Farm Credit is to build a team of experts around our customers. The contact point is the financial services officer and it branches out to include business services, planning, appraisals, crop insurance, tax and record keeping. And we continue to build strategic relationships with other service providers from which Frontier Farm Credit customers can benefit.”

“We feel very strongly about keeping our loan products and services competitive but we recognize it’s important to add further value, to have a more complete relationship with customers and to contribute value that can make them more successful. Helping them manage risk from price volatility is an excellent example of that.”

From his viewpoint as a commodity broker and marketing consultant, Tom Leffler also believes farmers need expert advice in the marketplace. “Farmers today need to employ some type of marketing advisor,” he suggests. “Today’s market is a lot like today’s tractors. It’s so complex it demands specialized knowledge. Even more important, though, is that you need someone on your side who can focus on that aspect of your business. A marketing advisor can take some of the noise out of the daily markets and help a farmer select the marketing and risk management tools that suit him or her best.”

The higher level of “noise” in the market can be an extreme distraction for farmers with plenty of other things to do. “It can be intimidating and it can send you on some wild goose chases,” Leffler says. “It’s important to know your costs and know what you need to get from your production. Put that top-of-the-market thing out of your head and put together a solid, disciplined strategy for profitability.”

Frontier Farm Credit, according to Tony English, is uniquely positioned to assist farmers on all financial matters. “Our edge is our people,” he asserts. “Our people understand there is no boiler plate approach for the farms and ranches they serve. Situations are very individual and that means it’s important to have relationships with our customers and not just transactions — that way we can provide the expertise they need.”

And highly volatile commodity markets are a great example of where plugging in to a team of financial experts can have a very definite pay-off.

“For me, the bottom-line is to not let volatility drive you out of the game,” English concludes. “Risk can be managed. There are a lot of positives right now in production agriculture, but we need to be aware of risk management so we can take advantage of favorable prices and moderate unfavorable costs.”

To learn more about strategically tailored agricultural lending and financial services opportunities, visit with the folks at your local Frontier Farm Credit office.