Make decisions based on what normally works

Economics is not an exact science. It consists merely of laws of probability. The most prudent investor is one who pursues only a general course of action which is normally right and who avoids acts and policies which are normally wrong. - L. L. B. Angus.

The trick is to figure out “what is normally right” and “what is normally wrong.” For example, I have received several calls and e-mails about what to do with 2004 harvested wheat that is still in storage and about pricing 2005 harvested wheat.

Since I do not know what wheat prices will do or what the June 20, 2005, wheat price will be, I listen to the producer and try to figure out what they want to do and what fits best with their situation. This requires obtaining information about their farm and business goals. Both psychological and emotional issues must be considered.

If I do not think that what they want to do will have disastrous results, I normally agree with the plan. If I think that the plan is flawed, I try to get them to evaluate alternatives and modify the plan.

Since last October, I have been predicting that the central Oklahoma and Texas Panhandle June 20 wheat price will be $2.60. I felt relatively confident about this prediction between late January and mid- February when the KCBT July wheat contract was near $3.05 and the basis offer was a minus offer ($3.05 - $0.40 = $2.65).

Now the KCBT July wheat contract price is $3.62 and the forward contract price is about $3.22. Should a producer sell wheat in storage or forward contract for harvest delivery or buy a put option contract?

We know that 2004/05 U.S. wheat ending stocks will be about 550 million bushels compared to 546 million bushels last year and 491 million bushels in 2002/03. The national marketing-year average prices were $3.56 in 2002/03, $3.40 in 2003/04 and are projected to be $3.40 in 2004/05. This indicates that 2005/06 marketing-year average wheat prices may be about the same as in 2002/03, 2003/04 and 2004/05.

While the average annual prices were about the same, there were differences in harvest prices and price trends. The average June prices for Oklahoma and the Texas Panhandle were $2.91 in 2002, $2.82 in 2003 and $3.47 in 2004. In 2002/03, the monthly average price peaked in October at $4.51. In 2003/04, the monthly average price peaked in January at $3.80. And in 2004/05, the average monthly price was the highest in June at $3.47. The monthly average November 2004 price was $3.42.

United States wheat production only averages about 10 percent of world wheat production. World wheat production and ending stocks may have a major impact on U.S. wheat prices.

World wheat ending stocks are projected to be 5.4 billion bushels compared to 4.8 billion bushels last year (2003/04) and 6.2 billion bushels in 2002/03. Relatively low world wheat ending stocks last year (4.8 billion bushels) could have supported the average June wheat prices.

World ending stocks above last year and below 2002/04 and U.S. stocks about the same as last year imply that the harvest price should be below June 2004 ($3.47) and above June 2003 ($2.82). How much above $2.82 or below $3.47 will depend on the size of the U.S. winter wheat crop and expectations for foreign wheat production.

These numbers imply that it would be “normally right” to sell wheat that is in storage and that the odds are about 50/50 on forward contracting or hedging 2005 wheat.

The KCBT July wheat contract price is about $3.60. Using a minus 40-cent basis, the market is offering $3.20 for June delivered wheat.

The current cash price is about $3.40. The market believes that cash prices will fall about 20 cents between now and harvest.

Research has shown that writing down a marketing plan increases that odds that the decisions made will be normally right. Not having a written marketing plan increases the odds that the decisions will be normally wrong.

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