Demand vs. economy
As grain prices have crept higher this summer, specifically corn, the growing question is whether demand can either sustain or build. The answer on the surface is probably not, yet don’t be surprised if it does. What really matters is end user’s margin. Depending on what corn buyers receive for their product, the price of corn may be irrelevant. As feed prices move upward, we continue to hear more talk about how demand will shrink. In a general economic model, higher prices equal less quantity demanded. That is making an assumption that the output product price for corn buyers remains unchanged, while the input price, corn, continues upward.
If one were to take a look at a continuous live cattle chart, or for that matter energies, these markets have generally moved up in tandem with the corn market. Cattle component figures still point to profit potential, especially those who are buying feeders, buying corn, and then hedging the live market. What about ethanol? It is generally assumed that $7 corn would likely drive ethanol plants into the red. However, if crude oil prices stay in the mid to upper 80s or low 90s, margins may become questionable, yet plants will likely remain operational. A move to $100 higher for crude oil, and the price of corn at $6.50 or $7.00 becomes less important.
Many have pointed to the dairy industry saying it is in major trouble. If looking at deferred milk futures prices and today’s corn price, maybe so. Yet, nearby dairy futures are over $20, likely profitable levels with breakeven prices close to $18 or $19. The real question or concern is if the price of corn end user products declines rapidly before the price of corn can decline.
As an example, if deferred live cattle prices slide, the market will likely see cattle herd liquidation. Those not strongly capitalized will exit the industry. Ultimately, this puts upward pressure on live cattle prices. Feedlots will eventually see bottom line numbers in the black. In other words, the market will correct itself. The problem for cattle producers is the gray area between where corn prices stay higher and beef prices decline. In order to ward off this “gray area”, it is imperative that those buying grain know how to shift risk with their end product, whether it is cattle, dairy or other products through risk management strategies.
In the end, the question is who will win: the economy or demand? The answer is probably both or neither. Producers and buyers will make adjustments. This is nothing new; it is typical for an economic cycle. What is scary, however, is the high level at which commodity prices are currently. The potential risk that exists for both the producer and consumer of grains is greater than ever. Profits could turn into losses virtually overnight. It’s time to sharpen your risk management pencil, seriously preparing for whatever the future holds.
If you have questions or comments, please 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.