June 21, 2012 - Farmers might want to hedge their risks in what is turning out to be a very volatile year on the international market.
Mark Welch, an economist with Texas AgriLife Economist with Texas, told farmers at a recent crops clinic in Milam County that there is no way for an economist, or anybody else, to predict with any certainty what the market will do between now and harvest. The unpredictability of the market makes it ripe for hedging, he said.
"I think we're going to need some kind of price protection now against lower prices," he said. "The USDA has estimated a yield estimate of 166 bushels per acre. If the USDA is right, that should add to the ending stocks. That would surpass the all-time record yield, which was 165 bushels in 2009."
The record yield, if it materializes, would come at a time when corn supplies are very tight. The USDA projects corn use will be up 9 percent from last year, even as the demand for corn ethanol levels off. Corn exports are expected to rise even though growers in other countries are also projected to have strong yields.
The U.S. grows 40 percent of the world's corn and the European Union, which is currently fighting several financial fires simultaneously, is the world's number one buyer of that corn. Canada is second followed by China, which is going through a recession after years of unprecedented economic growth. Welch said that China's handling of the recession will go a long way toward determining demand in the months to come as will events in Europe.
"There will be tight supplies," Welch said. "The projections are for the tightest corn-to-use ratios since 1995. Demand is still very strong despite the financial issues in countries like Spain, Italy and Ireland and the recession in China, but there are a lot more than just supply-and-demand fundamentals at work in the markets today."
Just as a gambler hedges bets to limit risk in exchange for a potentially smaller profit, farmers do the same thing when they hedge against market changes by contracting to deliver a certain amount of product in a certain condition to a certain place at a certain time for a certain price. If the price goes up, the farmer loses part of what would have been his profit. If the price plummets, the farmer avoids the loss, which is absorbed by the broker or speculator on the other end of the contract.
Speculators, Welch noted, love a volatile market. Some of them are convinced the drought will continue and harvests will fall short of USDA projections, but milo is already being harvested in South Texas and other grain crops, like corn, are off to a good start.
"It looks like we will have a corn crop," Welch said. Joseph Glauber, a chief economist for USDA, said recently that the U.S. corn crop is two to three weeks ahead of schedule and appears to be on a record pace.
In describing various scenarios where farmers will make or lose money by locking in prices now, Welch pointed to one where the price increases at the end of the contract period.
"Maybe I lost money on a deal like this. but I might better off knowing all along that I'm going to sell at a profit," he said. "The thing is, there are just too many unknowns in the market for anybody to know what will happen to prices."
Producers can lock in prices now if they think the prices will drop, and crop insurance can help them hedge their bets against the weather. Either way, Welch stressed that farmers have to first know their cost of production to know their break-even point.
"It pays to be the low-cost producer," Welch said. "Recognize a profitable price and lock something in."