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Long-term Ag Profit Cycle: The Turnaround Is Coming
Since I first started trading grain futures in 1974, I have lived through a lot of major highs and lows in the grain markets. Several of my long-term customers – some have been with me 30 or more years – have been through these cycles with me. However, this year, the price collapse between May and October was one of the most severe I have experienced.
How does this compare to other major lows over the years? The fundamentals have changed so much that we find ourselves in uncharted territory.
Using corn futures as the major benchmark for grain prices and ag profits, the cycles have typically been 15 or 16 years low-to-low and 16 years high-to-high. This suggests that, following the major highs in 2012, prices and profits will put in a major low some time in 2015 or 2016.
Now, compare it to major lows of the past (starting with the 1980s). Is there going to be a repeat of what happened in the mid-1980s? My answer is no – for three reasons.
Cycle #1: 1969 to 1985
There were three major price cycles during the 45 years since 1969. The first major low started in 1969. The grain markets were volatile, but prices made a series of higher highs and higher lows until the major high in November 1980.
In November 1980, prices turned and headed down – way down – to the low in 1985. Of the three major cycles during the last 45 years, this drop was the most severe reversal. Commodity prices fell, and land prices fell. The huge drop created a major farm crisis that bottomed out between 1984 and 1987. It didn’t start to turn until the drought of 1988. This finally started to turn grain prices – and profits – higher.
What caused the sell-off in the 1980s to be so devastating? Do we have similar conditions today? The short answer is no because of the following three situations.
In 1980, the Federal Reserve Board started to battle to fight inflation. The prime rate jumped to 21%, and many farmers were paying 18% to 22% interest for one-year operating loans. Most farm real estate loans were on a floating rate, and loan rates were as high at 14% – if it was even available.
In 1980, the U.S. dollar was strong. The high interest rate in the U.S. brought a huge amount of global money into the U.S. for investments. The U.S. dollar index rallied to over 164. (To put this in perspective, in October 2014 it was 83.) As a result, grain in 1980 became expensive for foreign buyers, ag exports plunged, and grain prices and profits took a dive.
In 1980, farmers were in serious debt. Many banks in the 1980s gave loans against asset values. As land prices rose, the banks would lend more – up to 90% of the appraised value of the land.
Many farmers got highly leveraged and had debt-to-asset ratios of over 80%. In other words, they had debts worth more than 80% of the value of their farm.
As you can imagine, when land values fell by a third, the highly leveraged farmers were in trouble.
Some of the most aggressive banks were also in trouble. This created a downward spiral of lower values, and it forced sales that put farmland prices under pressure.
Cycle #2: 1985 to 1996
The second cycle started from the lows that developed in 1985. After 1985, prices rallied for 11 years to the high in the summer of 1996. From the peak in 1996, prices fell to the initial low in 2000.
Many of the long-term charts showed a double bottom in grain prices and profitability in 2005. This was an orderly decline. Many farmers held it together with a combination of good yields, countercyclical payments, and loan deficiency payments.
Cycle #3: 2000 to 2015/2016
The third long-term cycle started with the lows that came in between 2000 and 2005. From the important low in 2000, prices advanced to the major high in 2012.
Grain prices have now gone sharply lower for two years. I expect the next major low in grain prices and profits in 2015 or 2016.
What has caused the sell-off in this third cycle? Was it like Cycle #1 and the 1980s again?
Again, no. The 1980s have not returned and here are two reasons why.
In this recent cycle, prices got really high. When corn goes over $8 and soybeans spike over $17, it’s a lot more likely that prices will fall rather than rise. That means we shouldn’t be too surprised prices have dropped.
The other main factor in this cycle was the surge in U.S .and global production in the last few years. Higher prices have brought a lot of additional acres into production in the U.S. and around the world.
However, in contrast to the 1980s, today’s lower prices are being met with demand. So watch out! When the next global crop scare develops, we will have an even larger pool of end-users clamoring to buy.
Looking Back to the 1980s
Because I have had so many questions about what happened in the mid-1980s, I decided to go back and take a deeper look. Not with time travel, but the next best thing: my old copies of the Commodity Research Bureau annual reports and old data stockpiles at the USDA.
What happened to the grain fundamentals since the 1980s? What has changed in global grain supply and demand? The short answer is a lot!
Here are three huge changes since 1984.
The producers. Who is producing grain and where are they? If you look at the graphs in this article, you can see that corn and soybean production has increased somewhat in the U.S. over the last 30 years.
More interesting is what has happened in South America. Soybean production in Brazil has increased from 300 million bushels in 1984 to over 3 billion bushels in 2014. That’s a tenfold increase. In 2016 or 2017, Brazil will likely surpass the U.S. and become the largest soybean producer in the world.
The corn crop. Global corn production has increased also, and Brazil and Argentina have become large export competitors. However, the U.S. remains the largest producer in the world, in part, because its climate is the best suited to corn productivity.
The consumers. Who is using all of this grain?
For soybeans, China has been snapping up all of those beans. The dramatic increase in exports over the last 30 years has been due to the huge growth in exports to China. I expect that trend to continue.
For corn, the buyers are U.S. ethanol producers. They didn’t even appear on the charts in 1984. This year, ethanol plants are forecast to consume just over 5 billion bushels of corn.
Those three major changes give me five reasons why I don’t believe we will see a repeat of the 1980s farm profit debacle.
Farm debt levels are not as high. Banks now make loans on a farm’s ability to pay back the loan – not on its assets.
U.S. interest rates will move higher in the next few years. Short-term rates may even climb back to 3% to 5%. However, I do not think I will live long enough to see the prime back at 21%.
The U.S. dollar is trending higher – but not too high. The dollar index could move all the way back to 90 to 100. I do not see the dollar getting back to the highs (150 or more) that were made in the mid-1980s.
China and the rest of the globe will continue to demand more food. There will continue to be economic ups and downs, but the bottom line is simple: More people in the world are moving into the middle class. The demand for quality food (especially proteins) continues to grow.
Ethanol is here to stay. Ethanol production did not even show up on the charts 30 years ago. This industry will continue to be cyclical, but it is not going away.
What goes around, turns around
Farmers seem to have an intuitive understanding of cycles. They live with annual weather cycles. They see how a growth cycle can be influenced by outside forces, some of which are generally predictable (fertilizer, heat units, soil type) and some that come out of nowhere (hail).
As a result, plenty of farmers ask me about the outside forces that could change their farm profit cycles. The two main questions: What can make it worse? What can make it better?
What can make it worse?
If the U.S. dollar index continues to move higher and gets back to 100 or 120, then it will keep grain prices and farm profits under extreme pressure for the next several years. I would also be concerned if nearby crude oil futures close below $60 per barrel. This would be very hard on the ethanol industry and corn prices.
What can make it better?
To me the question is not ‘what’ but ‘when.’ The long-term global fundamentals are positive for agriculture. The population of the world continues to increase, and the number of middle class people who can afford to buy more protein is increasing. Meanwhile, the amount of land available for farming continues to drop. This spells good news for farmers.
The current situation reminds me of what one of my mentors told me 40 years ago. When the price of a commodity drops below a farmer’s cost of production for more than six months, it’s time to start buying that commodity. If the price stays below the farmer’s cost of production for more than 12 months, it’s time to buy some more.
Today’s buyers have been watching – and waiting – for these low prices. Undoubtedly they will buy – and then they will buy more.
So be patient and stay disciplined. Better prices will return.