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Risk premium can fade fast

05/25/2012 @ 1:08pm

It is easy to make a case for the highest price of the new crop year to come in the April through June time period. That principle is true for both corn and soybeans. That phenomenon can be observed by studying any random period of more than five years. In my market analysis, I use the 30 years from 1982 through 2011. I use May futures for soybeans and March futures for corn. I also evaluate the most recent five years to determine if the nature of the market has changed in the recent past. 

The annual high in futures prices comes outside of the three months mentioned just often enough to make farmers question the reliability of the spring high in developing a marketing plan. Nonetheless, the frequency of the yearly high coming during those three months happens often enough to make selling then a good strategy. 

Economists call this principle “risk premium”. In farmer terms, it explains that prices are the highest when risk is greatest. As risk goes away, prices drop. It seems simple enough, but molding that idea into a marketing strategy is not so simple. There are many reasons why selling during that period is difficult. 

The first and probably easiest to explain is that we never know how many bushels will be available for sale until after harvest. Some farmers have a lot of variability in yields. Others have consistent high yields. Which of those brackets a farmer fits into makes a big difference in his or her attitude about selling grain that is not yet produced. 

Second, while the highest price of the new crop year has very good odds of coming during the three month time period, the single month with the highest probability is July. The risk of waiting until July to make sales is that in many years the peak is already past. Then, you are stuck with grain in the bin at a price that is lower that was available early in the season. 

Third, risk premium drops as risks are eliminated one by one. Most of us have a mindset that defines the risk on our individual farms. In my case, my most feared risk is drought. For many, it is hail. For others, it is early frost. When evaluating risk for the crop nationwide, risks start to diminish when the crop is planted. That means around April 1 in most years. 

As the seasons pass, the risk becomes less and less until there is no longer any risk after harvest. Consequently, there is no longer any risk premium. At that point, the big factor becomes demand unless there has been a short crop caused by one of the risk factors. In that case, supply becomes a factor as well.  

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