Wall Street History

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Wall Street History

02/22/2008

Farm Update

I have had an almost 10-year relationship with a classic farm
family in the Oklahoma Panhandle in an effort to stay somewhat
current on the farm sector and as part of my ongoing research (in
addition to my week at the Iowa State Fair last summer), I have a
subscription to High Plains Journal, a weekly publication for
farmers. There are some excellent columns in it and one regular,
Ken Root, wrote a piece in the January 21, 2008 edition that I
found enlightening.

Ken and I have exchanged notes in the past and I asked his
permission to reprint the following which he graciously granted.
Ken has been an agricultural reporter for 34 years and is the lead
farm broadcaster at WHO Radio in Des Moines, Iowa.

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“Will agriculture follow U.S. economy into recession?”

Friday, January 11 showed the volatility in the commodity
markets as the U.S. Department of Agriculture released the final
report on 2007 crops. A simple rebalancing of yield and usage
panicked the trade and slammed corn, wheat and new crop
soybeans against the limit up barrier with analysts predicting
more up trends in trading sessions to follow. In this euphoria of
record high grain and hay prices, there is the underlying threat
that the U.S. economy will dive into recession. We’ve been here
before and I hope we don’t make the same mistakes this time.

The boom in grain prices seems to come from several aligning
factors, but primarily, the credit can be given to a weak U.S.
dollar in world markets. This has distorted our view of the rising
costs, and rising value of commodities. Adding to this, we’ve
seen incredible demand for oil and dismal wheat harvests
worldwide, including Texas, Oklahoma and Kansas. The
mandate for increased ethanol production and the rush to build
capacity, now makes it the second largest usage of corn behind
livestock feeding. Exports accelerated, even at higher prices,
because (thanks to the cheap dollar) the real cost to most buyers
was still within their budget. The commodity index funds are
giving the market even greater strength, as they seek to make
money in the seemingly unending uptrend. Every time the
market tops out, another surge of positive news comes along and
sends it higher and the funds amplify their gains.

All this good news masks the future when a number of scenarios
could play out: a grain embargo, opening of the conservation
reserve, eliminating ethanol price supports or rolling back
biofuels usage mandates.

It seems unlikely that peace will break out in the Middle East; so,
the ‘risk premium’ on oil should remain intact, but there will be a
change in the White House in one year and the new president
will almost surely change the strategy in Iraq. The new
administration is also likely to implement programs to address
global warming and this should favor agriculture and ‘green
energy’ production.

In the 1970s, following the big sale of grain to the Soviet Union,
U.S. agriculture was doing very well as inflation spiraled and
recession loomed. Based on paying off debt with cheaper
dollars, farmers made good decisions in the late ‘70s that became
bad decisions in the early ‘80s and sent the industry and the
culture into its bleakest times since the Great Depression.

Now we are completely through the down cycle and even have a
new generation that has only recently known prosperity and has
not seen a great market reversal. Everyone needs to get rich once
and lose it, to really appreciate it the second time around. The
older generation, however, is not doing much better as a group of
seventy-something men in Iowa excitedly informed me last week
that they were holding large quantities of grain and looking for
the top of the market. The excitement of the moment caused
their physical characteristics to be similar to four-year-old boys
needing to find a bathroom.

In the overall economy, the threat of recession often causes a
recession. Consumers who hear the news and cut back on
spending exacerbate an already precarious situation and the
economy begins to collapse. As the recession becomes more
obvious, the downtrend accelerates. In agriculture, the classic
setup for a fall begins as an up market builds excitement and
farmers hold grain away from the buyers until unknown events
cause a market topping action that would be inconsequential at
lower levels. The downtrend causes nervous sellers to dump
their grain and the market collapses. Hope, greed and fear are
still with us.

For those who make a living from livestock, the recession is
already here. The combined factors of higher costs and lessening
demand have pretty much eliminated profit from your ledger.
How smartly you’ve contracted, or how quickly you can retreat,
will decide your fate. People buy less steak when they are
pessimistic but they do stay home and eat more hamburger, pork
and chicken.

What is playing out here is pure American capitalism. It is based
on risk, reward and freedom to fail. Note that I have not
mentioned the new farm bill, as it will only come into play when
prices are low. The new U.S. Secretary of Agriculture is an
afterthought in Washington, D.C., as his role is much less
important now than it will be at the depth of a recession or
following a market collapse.

As I see it, this is going to be a bumpy year for grain farmers. It
is going to be a grumpy year for livestock producers and it is
going to be a volatile year for the U.S. economy. With the length
of this commodity price uptrend going through two harvests and
the potential for forward contracting five dollar corn, eight dollar
wheat and twelve dollar soybeans for one to three years, the true
character of the farmer is going to come out. Will you be caught
up in the fallacy that “this time it is different” or will you
remember history and prepare for the economic cycle to gyrate
into the future?

[Note: Since Ken Root’s piece in January, commodity prices
have continued to rise across the board.]

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Wall Street History will return next week.

Brian Trumbore

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