fixed cycle of production

The grain markets follow a fixed cycle of production, flowing from planting to harvesting at specific times of the year. The National Oceanic and Atmospheric Administration and the United States Department of Agriculture (NOAA/USDA) Joint Agricultural Weather Facility refer to these stages as moisture and temperature sensitive stages of development. During these stages of development, the crop is vulnerable to damage from the forces of nature.

During planting, too much rainfall can make fieldwork difficult to impossible. Late plantings can result in loss of acreage or late development, which can result in a lower quality crop or lower yields. Too little rain can prevent seeds from proper germination, resulting in loss of production as well. Hence, during the planting effort, farmers are somewhat at the mercy of nature, and thus the risk to the crop is great.

During pollination, or the reproductive stage of crop development, excessive heat and a lack of precipitation result in poor pollination and lower yields. Extremely low temperatures and/or excessive rainfall can hamper pollination as well, resulting in crop loss. Excessive heat, lack of wind, or drought conditions can also hamper pollination, or stress the crop causing a poor pollination. Because this stage of development is so extremely weather sensitive, prices tend to rise reflecting the risk to the crop.

During the later stages of maturation and/or harvest, excessive heat can cause crop damage. Prolonged exposure to moisture can reduce quality, allow mold-based diseases to spread, as well as delay the harvesting effort due to the ground being to muddy for fieldwork. Early frosts can damage crops as well.

Because grains are produced annually (once a year, in most cases), supply is replenished only once a year. Grain usage, though it ebbs and flows, is spread out throughout the year. Thus, yearly production must be rationed. The rationing mechanism isPRICE.

Price is a function of not only current supply but perceptions of future supply as well. When current supply is plentiful and/or future supply appears abundant, grain prices tend to decrease as consumers become less anxious to secure supply at today’s prices and producers market their crops more aggressively to secure today’s pricing before prices erode more. When supply is relatively scarce and/or future supply looks uncertain, consumers tend to be more aggressive in pursuing available supply and producers less ready to part with production, which results in rising prices.

The amount of change in price due to future supply perceptions is known as the RISK PREMIUM. When future supply is perceived to be tight or limited, the futures markets tend to “build a risk premium” into prices, with prices tending to be higher than one would expect based on current supply and usage patterns. As future supply perceptions become more secure, the futures markets tend to “remove the risk premium” from prices, resulting in pricing closer to the lower level that reflects supply and usage patterns. Hence, the futures markets tend to reflect the marketplace’s perception of future supply by increasing or decreasing the risk premium factored into prices based upon how secure it feels future supply is.

Because crops are most vulnerable to damage at Planting, Pollination (reproduction), and Harvest, futures prices tend to reflect this by increasing in prices to compensate for the uncertainty surrounding future supply. Because markets are emotional, driven by the forces of fear and greed, prices can reflect irrational expectations about the future… essentially destroying the crops in the pits of Chicago based on these emotions during the three critical stages of development.

We have coined the term The Three Destructions of Grain Crops as a description of the “irrational exuberance” – to quote Federal Reserve Chairman Greenspan- which occurs in the building and removing of risk premiums. Understanding the relative risk associated with a crop during certain stages of development can be a useful guide in understanding grain pricing. The size and extent of risk premium varies greatly from year to year, based on current and perceived supply and usage patterns. Though there is no guarantee that this pattern will continue in the future, it has served as a guideline in the past.

Spring Planted Crops

Corn and Soybeans are planted in the spring. Corn planting in the United States typically begins in late March and is completed by mid to late May. During March and April, possibly in response to planting worries, Corn futures have gained a total of 27 ½ cents in the last 19 years – see table at right. Soybean field preparation and planting typically lasts from mid March through May. During the early stages of the planting effort (March & April) soybean futures have gained a total of 266 ¾ cents in the last 19 years -see table at right.

The Corn crop typically pollinates in late June and early July. During the month of June Corn futures have gained a total of 19 ¼ cents in the last 19 years. During August, Soybeans begin to set pods or reproduce. In the last 19 years, August has seen Soybean Futures gain a total of 93 ½ cents. Though reproduction is a very weather- sensitive time, even a poor pollination ensures some future production so the market tends to factor in a smaller risk premium than at planting.

Harvest delays, or at least the fear of such, tend to grip the market most years. Corn is typically harvested in October, which in the last 19 years has seen prices rally a total of 11 ¾ cents. Do note that harvest concerns, like other market worries, tend to happen before the fact when uncertainty is greater. Soybeans are typically harvested in October and November, which combined have seen Soybean prices decrease a total of -6 cents in the last 19 years, despite all the talk of harvest pressure.

The most telling evidence that the futures market builds a risk premium into prices during the Three Destructions (planting, pollination, and harvest) can be seen in the table above entitled, Three Destructions Vs. Rest of Year. Though one can’t say for sure that these tendencies will continue in the future – given changes in farming –but historically the grain markets have experienced the bulk of there gains during times of the year when the crop is susceptible to damage.