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Bryan Doherty: Permanent volatility

The last 5 years have seen dramatic shifts in commodity price
volatility. It's highly likely that this shift in volatility is here to stay
for the foreseeable future. As we take a step back and look at history, the
markets are merely a reflection of a number of historical events that have
perpetuated today's increased volatility in commodities.

We'll break down the historical relevance into 3 basic components:
demand, supply, and what we will term knowledge. We'll take a look at these 3
variables, however, they all point to one common theme, which is increased
price activity due to increased world participation.

From a supply standpoint, the isolation that countries exhibited in the
1950s all the way through the 80s changed in the 1990s, starting with the fall
of the wall in Europe. As isolation decreased and capitalism increased, so did
a growing need for food and energy products. The world experienced ample supply
inventories, however, as demand responded to low priced commodities, it may
have been just a matter of time before the usual way of doing business changed.
The usual way would be producing enough inventory for countries to get by on
their own. However, as their populations increased, and middle classes,
especially in India and China, have grown, the need for increased products also
grew. As the world shrunk, the need for supply continued to become more
relevant. The ability to move product, through increased shipping abilities and
commerce, aided a growing demand market.

From a supply perspective, the world has generally been able to keep
pace, or even ahead of demand in most years. However, the last 5 years have
certainly changed the outlook of just how supply problems elsewhere in the
world can ripple throughout the marketplace. The rallies in the agricultural
commodities in 2008 were on the heels of poor wheat crops, especially in Australia.
The world became keenly aware that supply suddenly wasn't so abundant, and that
3 consecutive years of Australian drought impacted commodity prices. Throw on
top of that some weather issues in 2008 here at home, with hundred year type
floods in June, and the perfect storm for a supply and demand driven market was
in full force. An economic meltdown months later had world economies reeling,
and therefore, demand began to slide. However, over the last 2 years, economies
have stabilized, and in parts of the world, especially China, has grown
substantially. This, in turn, creates potential supply issues. Markets have a
tendency to move on perception, and the big perception this year is that China,
barring less than ideal crops in China or elsewhere in the world, could gobble
up many of the world's excess inventories. Thus, there will be increased
volatility into 2011.

Investors look for opportunities. Those who are shrewd and see a
changing world and marketplace understand the relevance that commodity markets
play. Managers of large pools of money, also referred to as hedge managers or
fund managers, found opportunities to leverage assets using futures and options
markets. This new knowledge and these new players have helped to provide
underlying support for markets. Demand for investments is also heightened from
both the food and fuel sectors. As a manager of money, you are looking for
opportunity, and this means exploring your horizons. The increased money into
commodities over the last decade is a proven indicator that the world is well
aware of tight inventories and how important world commerce, weather, and other
supply and demand factors can quickly change price outlook.

When adding these 3 elements together, it makes for an environment where
prices are unlikely to reflect significant supply increases in the foreseeable
future. The odds are also high against declining demand. That means, as the
market perceives a few bushels too many in a corn crop, prices could plunge $2,
and if the market perceives a supply shortage of just a few bushels, the market
could rally $2 or $3. Increased volatility means increased opportunity. Those
who are prepared will likely fare well. As prices increase and inputs follow,
farmers are probably at greater risk than ever that one year of marketing
mistakes could wipe them out. Therefore, the challenge to farmers is to be
acute marketers; aware of all marketing tools and the knowledge and discipline
to use them.

 

If you have comments,
questions or suggestions, contact Bryan Doherty at 1-800-Top-Farm, Ext. 129.

 

Futures trading is not for everyone. The risk of
loss in trading is substantial. Therefore, carefully consider whether such
trading is suitable for you in light of your financial condition. Past
performance is not necessarily indicative of future results.

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