But it will be up to individual growers to make the most of the new safety net provisions of the Farm Security and Rural Investment Act of 2002 and avoid falling back into the low-price-received, low-return scenario that followed the passage of the last farm bill, observers say.
One key to fully participating in the expected recovery will be improved marketing, says Carl Anderson, professor and Extension economist-cotton marketing with Texas A&M University in College Station.
“Although producers do not individually control price, they do control when and how to price,” said Anderson. “Price movements in cotton carry a great deal of uncertainty because of changes in weather and resulting yields, in foreign and domestic policies, in government and trade policies and in supply and demand forces.”
Anderson says that if one lesson is clear from recent years it is that growers must plan to manage financial risk.
Even in the worst years of Freedom to Farm, he notes, “there were producers who made good marketing decisions and received higher returns than if they had had to solely rely on government payments.”
Part of making good decisions is having a plan or what Anderson calls “a logical approach in deciding at what price to sell or buy and by what method to establish that price. That requires an understanding of how and why prices move up and down.”
Growers should know the basics of supply and demand, but understanding technical signals can also help in timing pricing decisions. “In the short run, traders tend to follow the technical signals.”
Anderson says a marketing plan is an essential step in effectively managing price risk. It should include: an evaluation of the financial position of your business, risk-taking philosophy, timing of cash flow, estimated breakeven cost and a realistic profit margin based on selected pricing strategies.
“A computer can help calculate expected income for each crop,” he says. “Then use tables and charts to set total levels of income needed to cover cash and total expenses and an acceptable income for the operation.”
Evaluating the financial position of the business helps determine the level of risk that can be absorbed without encountering severe financial problems. Anderson suggests growers start with a financial statement and then calculate debt-equity ratios based on short-, intermediate- and long-term debt.
“A review of repayment history and repayment capacity puts debt-equity ratio into perspective,” he notes. “Consider timing sales to meet cash flow needs. Payment of expenses influences the pricing method chosen. Income from pricing strategies that pay at harvest is usually preferable to storage.”
An estimation of costs and returns is critical to the economic health of the business, according to Anderson. “If you have trouble showing profit on paper, you should consider any relevant alternatives before the financial obstacles become too big to overcome.”
Growers should develop a plan based on market expectations from reliable outlook information, preferably from several sources. “You can gain a better understanding of markets by reviewing historical charts on futures and cash price movements relative to supply and demand,” says Anderson.
“Market forces involve ongoing changes. Therefore, you should update market expectations often. Organizing a marketing club or joining an existing club is a good way to learn more about markets and to keep informed.”
Growers should recognize that prices often will be lower at harvest than at planting. That could be the case in 2002 if the new farm bill results in more acres being planted, as some predict.
“We were expecting a decrease in acreage of about 10 percent,” said Anderson, who spoke before the House-Senate conference committee negotiated a farm bill agreement. “If you get the House bill with its guaranteed target price, we may be back to the same acres or higher.”
Anderson says he recommends the use of options, particularly out of the money call options, in most marketing plans.
“You can consider buying December call options at 51 to 52 cents (because of the cheaper premium) to protect against the upside and protect against the downside with the government loan,” he said. “Last year, some growers purchased December 01 60-cent puts for 2 cents early and netted 72 cents for their crop with their LDP.”
Whatever strategy growers decide, they must be ready to act on it when the markets or a combination of the government program and the markets offer them a realistic price, Anderson says.
“Markets are not going to give you anything if you do not take action to implement your marketing plan. Price a part of the crop if a realistic price level exists. Don’t try to pick a market peak – the peak is only known after it happens.”
With more U.S. cotton being exported than used in domestic mills, markets are likely to be more volatile in the coming months. “A move of 30 cents over a year’s time is not that unusual,” he notes. “That makes it more important that growers use options or other marketing strategies to protect against the risks that occur with such moves.”
For more price risk management information, Anderson suggests growers see http://trmep.tamu.edu/.
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