Episode 10: Perspective on Global Price

You’ve got enough to focus on: don't try to out-guess the global market; focus on operating within it. Gabe and Rodney cover the importance of the South American crop to a U.S. farmer, the wisdom of crowds, and seeing farmers as scientists. Plus: how the market shapes its futures price. 

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Transcript

Rodney: South America, man. So we had some questions around is China buying enough beans and how that affects the market and all that kind of stuff. I'm curious what you think. I frankly think farmers paying that close of attention to South America is a bad thing for their operation. Any thoughts on that?

Gabe: Do you mean to tell me it's hard to be an expert on South American agricultural production from Central Illinois?

Rodney: Yeah, exactly. Let alone bushels to metric tons, which I've been doing this for 15 years. Still can't figure that out in a reasonable manner.

Gabe: And dollars to Brazilian reais and sometimes they don't even talk about metric tons. They talk about bags down there.

Rodney: Yeah.

Gabe: But that's a quantity, right? A unit. A lot of that goes back to just core principles around trying to orient your decision-making around farm profitability, as opposed to trying to outguess the market. And so when you start paying attention to Brazil or currency rates or what a president's Tweeting, right? And any of those types of things, you're starting to walk really quickly into the space of a trader, as opposed to in the space of somebody running a business, trying to hit profitability targets.

Obviously in so far as those things are irrelevant, just like you want to stay on top of the weather. You probably want to stay on top of what's happening globally in your industry. But at the same time, I think driving a lot of your decisions around what happens in South America doesn't make a ton of sense.

I spoke to a handful of farmers. It was about a week and a half ago now. And one of the things they talked about... I think you and I talked about the stickiness of corn planting, right? So obviously with the ratios being what they are, there's a lot of discussion around how many acres are going to switch from corn to soy. And so two things from that conversation. One was it was just a handful of farmers, but they absolutely reinforced the stickiness of the corn.

Rodney: They love corn.

Gabe: And in fact, some of it, it was because they just had a lot of discipline around their grain marketing. So they just had judged what they're going to grow this fall a year ago. So there wasn't really a decision to make. But the other piece that was brought up is China's still very much on their mind, like as a buyer, right?

We haven't seen the big uptakes in soy purchases that have been hoped for. Obviously COVID, there was a whole bunch of uncertainty in there, but also it doesn't help that we keep hearing rhetoric around potentially taking additional punitive actions against China ambiguously because of COVID. It's unclear, but all those things like on top of the normal stickiness that sits with somebody who's planning on planting corn, continuing to plant corn, it creates a whole bunch of uncertainty about what those prices will look like for soybeans. And I think especially on the cash level, right? Like even if you lock in the futures today, generally. You've told me over and over again, with set basis so much closer. And so if China's a problem, your future schedule might be great. But if the beans aren't moving, they're not moving and we'll see those back up, too.

So, it reinforced the default behaviors that we expect to see around not a ton of acreage switching, but the China thing in particular, that had fallen down a little bit with everything else going on, at least in my mind, but it's still very much top of theirs. And so I'm sure there are other things that we haven't talked about that might point to people like that are... I would say are more structured than, well, I was going to plant corn, so I'm going to keep planting corn. And so like uncertainty around soy. I don't know if you've seen anything on that side of it.

Rodney: Yeah. We can be hard on farmers talking about this, like talking real about our impression of farmers. And I think those are two different things. One is, hey, I made some really good marketing decisions and I decided I'm going to lock in corn a year ago. And that's my thing. Like that's a reasonable thing. I think our experience lately is a lot of guys didn't have much sold ahead. So those guys that did, for sure, I agree there was plenty opportunity on corn and they should be continuing to plant that. Anybody who doesn't have it sold ahead today, you're kind of betting on the come, right? For higher prices specifically for corn, which makes me think about... I'm afraid that when guys are watching like, hey, what's going on with South America? How much are they focused on what they hope will go on with South America versus their current position? Or what they actually think is going to happen in South America?

Gabe: Well, that goes back to the tried and true risk of confirmation bias, right? Like we all want the markets to go up. So we all look for stories about what that support that belief. Yeah. It's a very easy trap to fall into. Yeah. So I would say again at the top there, you should have some awareness what's happening in South America. I don't think it should drive the decisions that you make on your farm. Like those go back to profitability. And I think last week you were saying you were doing some of the math on the soybean stuff and it's not that bad. Like it's not killer years, but it looks all right.

Rodney: Yeah, exactly. I mean, for anybody that hasn't done the math on your soybean profitability, please, please just crunch the numbers today. If you want to feel a little better about yourself, unless you're sitting at home thinking, man, I'm going to put money on soybeans right now. If you're anything shy of that, I'd say go ahead and crunch the math and see what happens. Yeah. I very much view the South American thing as kind of noise, except it's noise when I'm making my day to day decision. So that is like, what am I going to do today? South America, exports, all that are noise. I think if I'm asking myself the question, why are we in the world we're at today, right? Or why is the price that we're at today, then it's super relevant to me. And that actually helps me make decisions.

Rodney: So I think of inverted markets. So say carry market. Farmers love carry markets because the way to take advantage of a carry market is to carry grain, right? So like that's good. Inverted markets are a little different story. And I've had plenty of experience with farmers where they see an inverted market and they also don't want to make a decision. Right. So when you're dealing with an inverted market, you're saying, hey, I don't care what you do, but we should be doing at least basis contracts. Right. There's one way to manage that risk. And a lot of times the farmers saying, man, I don't know. I think the market's going to go higher. Or I think for some reason I'm going to get a higher price later. And I think if you're not in those situations, paying attention to those bigger reasons that we have an inverted market into the next year, then that's a dangerous thing.

Rodney: Right? Like I think you should understand back to the South America thing when we see a big inverse in like January in soybeans, that is usually related to the fact that there's a big crop coming in South America.

Gabe: Absolutely.

Rodney: Right. So if my bias is, hey, I want to hold beans past January for some reason, then it's worth looking at that South American crop and saying, hey, maybe I have some reason to believe that I know more than the rest of the market.

Gabe: Well now, hold on there. In what world do you have more reason to believe you know more than the rest of the market?

Rodney: Man, I'm a boots on the ground guy, Gabe. I know more. I know what's happening in the cornfields in Blackstone, Illinois.

Gabe: I was going to say, I know you know what's happening right there. I absolutely believe that 100%, but I think that's part of the challenge, right? When you get those big inverse in January, in the Jan futures, if it's going to come back, you'll also see that in the more deferred futures months. Right? You'll see it come back in the March and May and in July. I think that's a critical piece of it and why I'm a little dismissive of focusing so hard on any given piece is because the market, obviously it doesn't know everything, but in a given moment, I think it does a good... This is the traditional economists than me, which is much smarter than the behavioral one. But I do believe it is a reasonable reflection of the world's opinion of price.

Gabe: How much time do you think it takes? So when you're trying to make a decision on this stuff, right? Like when you start to have those opinions, like those are trading opinions, you're speculating on whether or not the price will go up or not. And so when I think about doing that, it's really hard for me to imagine a world where the farmer's got time to do it well. That's kind of what it comes down to. There obviously are plenty of people in the world who spend all day, every day looking at that. And then there's teams in the world that spend all day, every day looking at that. And none of them get it right all the time and the best ones get it right a little more than half.

Rodney: Like literally 50.5%.

Gabe: That's right. Yeah. Yeah. And they're just better at managing the losses a lot of the times and they go harder in on the gains, but it's a person and it's teams of people or entire companies focused on just that thing. And so the idea that somebody who's got a day job and a family and everything else, when that's not the only thing they do, I think you're really under the gun in terms of trying to trade against the market. So I think that's important context when we start to think about some of these things because if you're running an economic model on soybean prices that has Brazilian production in as an input, kudos to you, but that's really where it needs to come in. Right?

Rodney: Yeah. Right. Not, hey, I heard on the radio that Brazil's crop is 10% worse than we thought it was last week. Right?

Gabe: That's right.

Rodney: And then the other thing I think about farmers, I think personally, I think farmers are too hard on themselves around grain marketing. Right. So they generally think that people out guess the market, which we know is not true. Right. I think you're exactly right. It's more about managing your downside risk then really out guessing what the market's going to do. And I view farmers-

Gabe: As scientists. I think about them as scientists.

Rodney: Exactly right. And while I think it's appropriate to have a general understanding of what's going on in the world, like they should know that. But I was kidding earlier when I mentioned that I know more about the market or whatever. I mean, I'm like you, I very much view the market as that is the truth. Right. So I'm going to focus my efforts on how do I operate inside of what the market knows, because I just assumed the market knows everything. One of my favorite things in the whole world, and I just pulled it up here on my computer is this NPR planet money podcast that they did about 17,205 people guessing the weight of a cow. Have you heard about this?

Gabe: No, was the average of that correct?

Rodney: Yes. Like remarkably correct.

Gabe: So that's the wisdom of crowds principle.

Rodney: A little background. So the average guess, so they just posted a picture of a college. Penelope, the cow, they posted on Google and said, hey, come guess the weight of this cow. So the average guest came in at 1,287 pounds. The actual weight was 1,355. That's pretty reasonable for a bunch of random people looking at a picture.

Gabe: Yeah, yeah.

Rodney: Literally looking at a picture. And then the other thing they did was they purposely picked a cow that was different than Google's answer for what an average cow weighs. So if you look up Google, the average cow weight is 1,500.

Gabe: So it went lighter and-

Rodney: Yeah.

Gabe: So clearly they saw that, that it was lighter.

Rodney: Exactly.

Gabe: There's a book called Wisdom of Crowds, if you ever read it?

Rodney: No.

Gabe: Okay. So it was really helpful when I think about like three really formative books. So we talked about the Medici Effect a while back, there's Wisdom of Crowds, which we'll talk about now. And then at some point I'm sure we'll talk about Little Bets, which is another great book, but together they form like a pretty solid business philosophy. So Wisdom of Crowds is really about if you take a bunch of different people and ask them their answer to a question, so once you get to enough of them and you don't let them influence each other. Right. So that's an important piece.

Rodney: That's key.

Gabe: Right. They can't talk to each other and have them whatever, vote on the weight of the cow. You'll generally almost always get an answer pretty close to right. So that book opens up with a pretty cool story about trying to find like a sunken treasure or sunken ship. I forget which one it was, but they talked to these people and all these different disciplines about okay, do whatever analysis you do to figure out where this thing would be. And so then they overlayed all those different analyses onto a map and basically came up with a weighted average of, oh, it should be here. And it was there. And so none of them on their own were right. And when you put them together. So when you pair that up, this is part of building our business philosophy podcast.

Gabe: So when you pair that up with the Medici effect, right? So think about the Medici effect. This is about getting different disciplines in the same room together. And so when you take those different disciplines and those different people, and you have them work on a problem and lean into like their diversity of perspective, what you're really doing is creating kind of a wisdom of crowd situation. Right? Any of those parties on their own may not have the right answer, but as you start to overlay them with each other and you put those ideas through that gauntlet, when it comes out the other side it goes almost through a crucible and the idea is hardened. But it requires not only having the diverse perspectives, but leaning into keeping those whole. So you don't want people to move closer to each other. You want them to hold their lines.

Rodney: Yeah. I've already put my farmer hat on and I said, oh man, new podcast out. I'm going to use the wisdom to leverage my operation. And I'm going to find a group of people and just randomly ask them what the price of corn should be in six months. And as long as I ask enough people, I can make the right trading decisions based on that.

Gabe: That’s March futures.

Rodney: Yeah, exactly. So if you're a farmer listening to this, this is already done for you.

Gabe: It's already done. Yeah.

Rodney: That's right. Yeah. So then it just comes down to, you can't out guess the futures market, I don't think. So I love the futures market. I love that it is also the future. Right? So to your point, one of the things that farmers forget about is that there is a March futures, right? So the price of corn today is based off July and the price of corn in March is based off March. And that is what we think the price will be in the future for that delivery period.

Rodney: So let's talk about a couple of things I know that not everybody knows. All right.

Gabe: Okay. I'm excited.

Rodney: Yeah. So we know because I'm a smart green guy, that there is a seasonal trend where corn futures, and soybean futures to some extent, this time of year tend to rally based on uncertainty in the market. So it's going to be... I have a farmer that I love working with that says we kill the crop three times on average, right? So every year you kill a crop three times. So I'm certain because I know that we're going to kill the crop here at some point in the next, say, six weeks. So shouldn't the market already know that? And if that's the case, doesn't everybody already know that and that's already figured in? How can that happen?

Gabe: So I guess this is where we talk about net present values. So what the price of the market is right now is reflecting a whole bunch of different things that could happen. Let's pretend one of the outcomes is some horrible drought moves through and we don't grow any corn, figuratively any corn. So corn prices go to $10. Well, the probability of that is super low, right? Both that level of drought and having burned through our massive carry out, and, and, and, and. So there's something, there's some story that gets us there, but it's really unlikely. And then as you come closer and closer to the current market, right? Like those stories become more and more likely. And some of them go the other way, right? Like, oh, it's a bumper crop for corn.

Gabe: Not only did nobody change corn acres, like it was record yields by an unexpected margin. So now we've got probable scenarios that happen that drive the market price down even further. So the kill the crop scenarios are in there. And so what happens is in any given moment, the market reflects the best understanding of the information available. When those kill the crop things happen, whatever the sensational story is that comes out, for me, the most acute version of that is when we're in the middle of pollination and you're looking at... The weather is getting updated every couple hours and every time it comes out, you see the market react to that. Because that's new information. So it absorbs it and it reflects it. And then it sits where it is until there's more new information. So further problems are priced in there, but they're priced at a lower probability then... They're not certain.

Gabe: So if it was certain, you would see the market right now move, but in the same way that we kill the crop three times, realistically, the crop also doesn't die. So the actual most likely scenario, even when we do see stories about the crop like being ruined for some reason, are those more boring stories that there's going to be a crop and everything's fine. So they compete against each other.

Gabe: So what happened in the moments where the market moves up in reaction to something that's put stress on production, it's because there's more information about that. And the probability of that happening goes up. And then we generally see it come back down. Oh, it wasn't as bad as we thought, and then we got to kill it again. And it bumps back up. And like, oh, nope, just kidding. Not as bad as we thought.

Rodney: Yep. Yeah. And when you talk about as bad as we thought, I was thinking about this this morning. I always feel like the market generally prices in the average worst case scenario. Right? So right now, planning progress is really, really good. Right. So we had some frost roll through my area. I'm not exactly sure how widespread it was. And we saw virtually no reaction to that. And I'm used to people being really pessimistic and saying like, oh man, we're going to kill this crop because we had some amount of frost and it tends to work out it's not as bad as we thought. Right? I don't often see where it's not as good as we thought.

Gabe: So let's go back to confirmation bias. Right. So you and I talked to farmers. And we want the market prices to be higher for them. And so we get to share in that confirmation bias where we look for things that will drive the market up. So the reason it's exactly what's going on here is the story is appealing. The pessimistic one, as you're saying... You're always pessimistic about production. It's actually super optimistic about price.

Rodney: Correct.

Gabe: That's that's the other side of it. So it's not actually pessimism. It's optimism. Here's another reason this price should go higher. That's really why those stories carry more weight with us. Why we feel them more. And so when they don't happen, the change is extreme because I mean, good golly, right? Like cash price. I was talking to somebody in Iowa, it was like $280 right now. And the last thing anybody's going to go do is go look for stories on why the cash price should go to $250. Right? I don't want to go look at that. But so then we go look for the stories about, yeah, you should wait. Yeah. It is going to get better. Let me tell you how things are going to get more exciting. So it just lines right up with that.

Rodney: I hate that I play right into your behavioral economics mind tricks. Rarely do we have a conversation where I say, hey, I'm thinking this thing and it's really different than what everyone else would think. You're like, no, actually that's exactly right.

Gabe: Yeah. You're normal, Rodney. Congratulations. Well, I think that's the big pain about behavioral economics is even when you understand it, you still feel those feelings. Right? Like I just said, I don't want to go look for the story that's going to tell me about cash prices dropping another 30 cents. That is a stressful thing for me to go do. And I don't even have a farm.

Rodney: Thanks for listening to the GrainWaves podcast. Every week, we analyze the markets to bring insight to challenging decisions you make every day.

Gabe: Sometimes we could all use more support. If you feel overly affected by stress, know that you're not alone. Visit our show notes to find resources that may be helpful for you.

 If you'd like to learn more about how Indigo can help your farm be more profitable, you can learn more here.

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