Managing Price Volatility

USDA study from 1987-1996 on commodity price volatility indicated that crop prices were more volatile than livestock prices, largely reflecting the importance of yield risk in crop production. Crops exhibiting the highest volatilities (exceeding 20%) included dry edible beans, pears, lettuce, apples, rice, grapefruit, and grain sorghum.

USDA economists pointed out that price variability changes not only within the year, but also between years due to year-to-year differences in crop prospects over the growing season, changes in government program provisions, and changes in global supply and demand conditions.

Volatility, or price changes, trigger the supply and demand adjustments that make markets work.  Producers are not generally concerned when prices are rising, but take declining prices very seriously.  Buyers have opposite reactions to price movements. At some point, however, large price fluctuations can begin to create problems, with both economic and political repercussions.

For U.S. farmers, high price variability can destabilize farm income, and its associated risk can inhibit producers from making investments or using resources optimally. Access to the appropriate risk management tools permit market participants to manage their price risk, while allowing markets to function efficiently.

The USDA study indicated that generally, combinations of crop insurance and forward pricing and price hedging are more effective in reducing risks than either strategy alone in most areas. However, there is no “one size fits all” risk management strategy. The USDA study authors concluded that “A fully comprehensive analysis of the farmer’s multi-enterprise multi-year risks would consider choice of enterprise and diversification, correlations between yields and prices in successive years, the degree of flexibility offered for changing enterprises and cultural practices in future years, and the age and financial needs of the farmer among other things.”

With Volatility, There is Opportunity

While volatility in markets may cause some sleepless nights, it also presents some excellent sales opportunities.  When the wheat market has a 30-cent trading range in one day, there could be a favorable selling price in there somewhere. If you have unsold grain, you need to have a marketing plan in place with firm price targets.

As I often recommend, place sell orders at your local elevator or with a broker.  It’s much too difficult to try to watch the markets every day, and the direction may change drastically from open to close. A “good til cancelled” order can help ensure that your marketing plan is executed. The GTC is a directive to sell at a specified price which remains in force until executed or cancelled by you, the customer.

Actually, there can be more opportunities than pitfalls in a volatile commodity market.  The trick is to position yourself to take advantage of the opportunities. Doing nothing will get you nothing, but pricing strategies and a few GTC orders at your elevator may help make your marketing less stressful and more profitable.  You just might sleep a bit better at night too.

—Betsy Jensen, Ag Commodity  Instructor, Northland Community and Technical College

What Steps Farmers Would Take to
Manage Financial Difficulties

	Small Farms*		Large Farms**
	Less than $50,000	$50,000- $249,999	$250,000- $499,999	$500,000 or more	Total U.S.
Management/financial strategy:	Percent of farms
Restructure debt	24	48	46	49	30
Sell assets to reduce debt	31	28	31	29	30
Use more custom services	7	18	17	20	10
Scale back farm business	26	23	20	24	25
Diversify into other farm enterprises	12	23	21	21	15
Spend more time on management	19	38	47	45	24
Use advisory services	19	22	28	26	20
Adjust operating costs	34	54	59	57	40
Improve marketing skills	30	47	53	53	35

*  Annual gross sales under $250,000.
** Annual gross sales of $250,000 or more
Source: 1996 Agricultural Resource Management Study, USDA Economic Research Service, USDA