Beware Income Volatility

Originally published at https://www.dtnpf.com/agriculture/web/ag/news/article/2017/03/15/beware-income-volatility

Picture someone who works for a salary. Let’s call him Jim, and let’s say that Jim makes $52,000 per year. Incidentally, that’s approximately the median salary of American workers. It means that every two weeks, after his employer has withheld some money for various taxes and what-not, the employer will direct deposit about $1,500 into Jim’s bank account. Easy as that.

For reference, the median farm income from 1996 through 2013 was about $48,000. Farm *households* made more than that, because there was typically some off-farm income coming in as well, but from just the profits of agricultural production, $48,000 was the number. If we strip out livestock farmers and just look at crop producers, the median farm income was $71,223.

OK, so let’s say Jim has a farmer brother, Joe, who’s expecting to bring in about $71,000 of crop farming income in 2017, compared to Jim’s $52,000 salary. Who has the better deal?

The obvious mathematical answer is that $71,000 is better than $52,000, but then you remember that salary workers typically receive a range of benefits — anything from health insurance to tuition reimbursement to retirement savings. Maybe Jim’s situation isn’t so bad. On the other hand, more than half of farmers are also getting their health insurance covered by some employer. According to USDA’s 2015 Agricultural Resource Management Survey, 89% of farmers had some form of health insurance, which was similar to the general American population. And 55.6% of farmers were covered by private, employment-based insurance, compared to 55.7% of the general population. So let’s assume that Joe the Farmer has a wife, Nancy the Nurse, whose employer provides health insurance for the family. Now we’re back to wondering if a person would rather receive a steady $1,500 every two weeks, or a larger total sum of $71,000 from annual crop sales.

The difference really comes down to volatility. Let’s say Jim shows up to work one Wednesday and his boss calls him into the corner office and says, “Hey, Jim, I’m going to give you a 0.7% raise in your salary. It’s not necessarily because of anything you’ve done well or badly, but just because I feel like it today.” That less-than-1% raise would be equivalent to Jim earning an extra $14 per paycheck, or an extra $350 over the course of a year. Not enough to get real excited about, but maybe he can take the family out for dinner or buy his kids some school supplies. Awesome.

But then on the very next day, Thursday, the same boss calls Jim into the corner office again and tells him he’s going to dock his pay back down and then some. Nuts. Now Jim will have $350 less to put in his yearly budget. If this continues every day, up or down by a few hundred dollars, then the chief attraction of Jim’s steady $1,500 paycheck becomes nullified. He can’t plan with certainty how much of his paycheck can go to a car payment, how much can go to a college savings account, etc.

Fortunately for salaried workers, that’s not how it works. Their income is steady, not volatile.

Unfortunately for farmers, their income is volatile, not steady. The “boss” in Farmer Joe’s scenario is the grain markets themselves. Recently, grain market volatility has been relatively low. Over the past six months, the average daily move in December corn futures prices has been 2.8 cents, either up or down. November soybean futures have tended to move about 6 cents up or down each day. In percentage terms, that’s equivalent to Jim’s $350 annual pay raise, or more like a $500 difference to Joe’s $71,000 income, up or down each market day.

Be assured that there will be days and weeks and months when the grain markets move more wildly than that. If corn futures prices dropped by their daily trading limit (25 cents per bushel) and soybean futures prices dropped by their daily trading limit (70 cents per bushel), then that would be more like a 6.5% dock in pay, or $4,600 lopped off of Joe’s $71,000 income (assuming his profit margins don’t change). Yikes.

Last month, USDA’s Economic Research Service published “Farm Household Income Volatility: An Analysis Using Panel Data From a National Survey,” which showed, among other things, how off-farm income can smooth out farm household income volatility from one year to the next. But it’s most alarming statistic, I thought, showed that the average magnitude of the change between consecutive years’ median farm income was about $20,000! That means if Joe, representing the median American farmer, does happen to earn $71,000 in 2017, he really can’t make a household budget and plan on receiving $71,000 in 2018. His expectation should be to receive maybe $91,000 … or maybe $51,000.

So that’s something to keep in mind with today (March 15) being the deadline to sign crop insurance forms and, more menacingly, with the annual Prospective Plantings report looming on the calendar (March 31). Corn futures prices have jumped by double digits on eight of the past 10 acreage report days, and double-digit drops have been as likely as double-digit gains. A couple of those years have seen the market lock limit-down or limit-up through the close of the session, but the average size of the move has been 4%, either up or down. Soybean futures have posted a similar history on the days that Prospective Plantings reports have been released, with a couple of limit-sized moves and an average expectation of 2% up or down, but they have also tended to follow up with another big move on the day AFTER the report.

One last warning — before you get too tempted to gamble that the report-driven market move will be upward at the end of March this year, before Joe the Median Farmer gets too occupied planning what he’d do if he made $91,000 instead of protecting himself against making $51,000, remember there was a 2010 economics study by Daniel Kahneman and Angus Deaton that showed people’s evaluations of their own lives tended to improve as their income rose toward $75,000, but didn’t really improve as incomes rose past that level. Maybe the median American farmer, with his volatile income and risks and all, is sitting right near a sweet spot.

© Copyright 2017 DTN/The Progressive Farmer. All rights reserved.

Unraveling Corn’s Seasonal Highs

Sell your grain at the seasonal high in the spring. That’s good advice, especially in normal marketing years with normal weather, normal demand, and normal influence from normal outside markets. Unfortunately, even if such a year ever presents itself, we still won’t be able to predict the exact future date on which the markets will hit their annual high.

Predicting that date, or even predicting the seasonal pattern of prices, has only grown more challenging in the last several years with strange influences from unseasonal demand-driven, investor-driven, or drought-driven rallies.
In the past four years, the corn chart has experienced peaks in early August, in early July, in May, and again in July. Even a farmer who genuinely believes the market will always revert back to its time-tested seasonal patterns might feel a little spooky these days about trusting too strongly in normal spring highs.

If the weirdness of the past several years could be sifted out, I wondered, would the data still show something meaningful about grain markets’ seasonal tendencies? Ideally, I wanted to pinpoint which day of the year has the strongest probability of establishing the corn market’s annual high. But it turns out that if you want the corn market to reveal its seasonal movements, the data requires quite a lot of coaxing.

The results turned into gibberish if I used the continuous front-month corn chart, which switches which years’ crop fundamentals it tracks throughout any calendar year or even throughout any September-to-September marketing year. They were also gibberish if I averaged or even indexed all the prices of the past 15 years for each day of the year. Extreme highs or extreme dates pulled the average far off from where the actual yearly highs seemed to cluster. The problem was they didn’t cluster around any one, simple answer.

Instead, I simplified the question to just this: Within a given year, when should a farmer hedge his upcoming crop of corn? The fundamental outlook for the upcoming crop is always reliably reflected in the new-crop December futures contract. So I looked at each full trading year — December to December — of the past 15 December corn futures contracts to find the best timeframe for pre-harvest hedging.

Fifteen lines on a chart showing the performances of the past 15 December corn contracts look like tangled, multicolored spaghetti. Fortunately, the spaghetti could be unraveled by marking the highs of each year and identifying clusters of dates (local modes in a tri-modal statistical distribution) when those highs tended to hit. Amazingly, those clusters happened in groups of years with recognizable similarities.
I pulled out three categories of years.

* Short Crop Years (2001, 2002, 2006, 2010, 2011, 2012)
Corn production in these years was less than 105% of the five-year average. The trading pattern seems to reflect ever-increasing concern about supply throughout the summer and fall. In five of the six years, the new-crop contracts hit their highs on August 21, August 30, September 11, November 4, or November 30. Discarding the one year that didn’t fit the cluster (2001), the average date for the new-crop corn market high during Short Crop Years was therefore October

* Normal Abundance Years (2000, 2003, 2005, 2008, 2009, 2015)
Corn production in these years was between 105% and 114% of the five-year average (yes, the definition of these categories seems arbitrary, but this is how the highs clustered). The trading pattern reflects normal anxiety and risk premium in the spring and summer when weather is most uncertain for the growing crop. In five of the six years, the new-crop contracts hit their highs on May 3, June 2, June 26, July 16, or July 18. Discarding the one year that didn’t fit the cluster (2003), the average date for the new-crop corn market high during Normal Abundance Years was therefore June 18.

* Supply Crush Years (2004, 2007, 2013, 2014)
Corn production in these years was above 114% of the five-year average and typically followed a shortage, therefore straining the industry’s storage capacity. The trading pattern reflects increasing bearishness as the crop develops favorably through the summer and the huge harvest looms closer and closer. In three of the four years, the new-crop contracts hit their highs on February 22, April 8, or April 18. Discarding the one year that didn’t fit the cluster (2013), the average date for the new-crop corn market high during Supply Crush Years was therefore March 26.

Of course, some annual highs were higher than others, and if I opened up the timeframe to consider a multi-year selling window, it all starts turning to gibberish again. Honestly, the best selling opportunity for 2009 corn would have been to tuck it away for three years and sell it in August of 2012. Similarly, a person could have hedged the December 2016 futures contract at $5.57 1/4 back on December 19, 2012. But it’s not advisable for a farmer to depend on predicting three or four years at a time. DTN Grains Analyst Todd Hultman wrote earlier this week about the chances of hitting new highs within a year-long window: “Spot corn, soybean, and wheat prices all reached or exceeded their one-year highs 61% to 68% of the time. While that may not sound bad, each grain had pockets of three or four consecutive years that went without reaching a one-year high — runs of bad luck that could put a producer out of business.”

In nine of the 15 years I studied, the pre-harvest highs for the December corn contract were the best opportunity to sell the crop, even better than anything offered post-harvest for grain that was stored. In the other six years, there were some higher highs the next spring, but they were rarely high enough to reimburse a farmer for his risk and carrying costs. That is not to say that storing *hedged* grain to capture carry isn’t profitable, only that the best-priced hedging opportunities have tended to be prior to harvest. Pre-harvest hedging works, and there are patterns when the best hedging opportunities have tended to appear.

Make what you will of all this. Remember this analysis was a study of historical data, not a prediction of future events. No one has independently verified my calculations, and I’m not recommending that anyone should buy or sell commodity futures or commodity options (or cash commodities) based on this analysis alone.

Furthermore, just knowing the historical highs for certain categories of years doesn’t solve the eternal problem of figuring out what kind of weather year it will be. Nothing will ever solve that problem. There’s no way to truly know, in March, how large the corn crop will be, or whether it will feel like a shortage, normal abundance, or a crush of supply. It’s comforting to know, though, that no matter how strange individual years have seemed, the corn market still shows recognizable seasonal patterns.

As for soybeans, they merit the same treatment and yield similarly interesting results, but for the sake of column space, we will have to wait until the next Kub’s Den column to unravel their seasonal highs.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

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