Volatility in commodity markets has a tendency to rev up our emotions, even for the most controlled business managers. The greater the move, the greater the emotional intensity.
There is no surefire way to eliminate our emotional connection to the markets or to know where prices are going. Yet we can use some basic principles of planning and analysis to better manage our emotions and enhance our decision-making.
Disclaimer: I’m in no way claiming to have the most effective marketing plan. Instead, my goal is to remind us of the basic value of a solid marketing plan based on disciplined decision-making instead of emotional reactions. Let’s look at four factors—accurate cost of production, risk assessment, margin calibration and action plans—that can help us reach this objective.
Costs And Risks. Everyone talks about the importance of knowing your cost of production. Unfortunately, many farmers don’t always put in the time to accurately understand costs. If we aren’t measuring all of our expenses accurately, how can we know when to make sales?
Another area that impacts our ability to accurately gauge production costs is overhead—in other words cost of living expenses. In corn, it’s not uncommon for me to see 30¢ to 80¢ per bushel in family living costs. Fooling yourself on the actual cost of production can only spell future trouble for your marketing plans.
A big part of risk analysis involves scenario planning along with stress analysis. By going through this process, you can get a clear picture of the dollars and cents at risk. The tool included at the bottom of this page can help you run scenarios and analyze the potential stress to your operation in the event prices, yields or both fall short of the expectations you had entering the growing season.
Margin Calibration. Once you have dialed in your accurate cost of production, document what a reasonable profit margin might look like. Keep in mind this might be a moving target depending on crop outlook, time of year and your risk tolerance. It isn’t sufficient to only have a profit margin in mind. Put it in writing or on a spreadsheet tool so the information is transparent and more formal to enhance disciplined decision-making. Assume a five-year average yield and consider what level of profit is reasonable for your operation along with the best timing and percentage of sales.
For example, if your cost of production is $3.90, you might want a price target of $4.40 to meet a 50¢ margin target. By watching price alone, greed and fear are more likely to enter into your sales. Remember margin management isn’t always about profit. Sometimes, it might be necessary to limit losses.
Action Plan. Determine which tools are best to implement your plan. For some, a simple cash marketing plan might be sufficient. Some of the best tools available are option strategies that set a price floor yet keep much of the topside opportunity open. When volatility is low, option strategies tend to be more affordable for managing risk and reward.
Adopt action plans before you need them. It will allow you to manage the market instead of the market managing you and your emotions.
Analyze Your Operation’s Stressors
Use a tool such as this one to stress test your balance sheet in the event prices or yields vary from expectations. Consider the possibility of negative and positive outcomes.