PRICE CYCLES IN AGRICULTURE AND MARKET VOLATILITY

An issue in Ireland that concerns me is the understanding of price cycles. They are nothing new. For a brief read on the subject I would recommend ‘An introduction to economics for students of agriculture; first published in 1980 and written by my former colleague at Wye College, Berkeley Hill.

To quote from the first edition; “Often they [farmers] are aware of periods when prices are depressed and of others when prices are above the anticipated levels. They also have the impression that a long-run downward trend in prices for their products has been occurring. Part of the difficulty in interpreting and anticipating price movements is that the price mechanism reflects a number of changes which are different ibn cause but which are occurring simultaneously”.

As a note, the long-term downward price trend can be attributed to the continuous investment in technology that occurs in agriculture. It has ensured that supply continues to move ahead of demand. At least that is the case with commodities that do not benefit from any product differentiation that adds value.

The existence of price cycles for agricultural commodities is well known in Ireland and that the accepted wisdom is that prices will move from trough to peak and vice versa. At times, it appears that the confidence in the cycle is such that one can plan their future secure in the knowledge that high will follow low as surely as night follows day.

For the author this is a cause for alarm. More so when it comes to loan finance. To put it simply, is it wise to borrow to survive the bad times on the assumption that rise will follow fall? And how sure can one be that the good times will allow the repayment of bad time loans?

The critical long-term planning factor should be the expected price at the bottom of a price cycle. Investment and borrowing should be made based on this downside price [with sensitivity analysis used to delve deeper]. Borrowing and investment should go hand in hand. Borrowing to plug cyclical downside shortfalls is not to be recommended; not least when the future repayment capacity is entirely reliant on the cycle providing a sufficient upside price.

One should also ask what triggers the ‘classical’ agricultural price cycles. Do they function in a comprehendible way in a globalized market? The classical cycle rational is that there is a time lag between investment and produce sales dates as it takes time to increase productive capacity; either breeding stock or farming infrastructure. A high price stimulate investment but sales volume expansion occurs later. As many individuals make the same decision, a volume surge occurs that depresses prices as the supply increase exceeds any demand rise. As prices fall, farmers then exit the market and supply falls. Lower supplies mean prices rise etc. etc.

Now how effective are the signals in a global market? Can we assume that the global markets for, say, milk powders are going to follow cyclical pattern? Are there too many variables at play? Are there too many supply-side influences at work? What about the numerous factors that impact upon demand? This is not just your local market but the many markets that compromise the ‘global’ market. So how great an influence will politics play within those markets? And what influence will the behaviour [and power] of market players have?

The above are far from the simple assumptions that underpin the ‘classical’ agricultural price cycle. Therefore, is it naive to assume that what goes around will come around? It is risky to borrow and lend on the assumption that the price cycle will enable loan repayments to be made.

By way of further explanation let us return to the milk powder markets of recent years.

The tainted milk powder scandal in China was a significant demand-side event. As was the Chinese economic boom. The combination turned China into a major buyer. These were market signals that the supply side responded to. Did, nevertheless, the supply-side players all make independent decisions without due regard to what other players were doing? Did this create a rapid rise in the stainless-steel capacity dedicated to supplying China? Almost certainly [apparently, the shipping industry did likewise]. Do we now have excess capacity?

We then had the Russian sanctions, the oil price fall and the slowing of Chinese economic growth to cause a demand-side slow down. Meanwhile production and processing capacity was on the increase. In theory, demand-side changes should follow through to processing capacity closing and farmers stopping production [although the ‘pain’ from excess processing investment may have been passed on to the farmer by more powerful processors].  Will it happen or will, for example, low grain prices over-ride the demand side influences on price? It all gets rather complicated.

We appear to be coming out of the milk price slump. It has, however, taken a significant intervention by the European Union to do so. It has funded intervention buying and a scheme to reduce milk production. Are these normal functions within the market? Will the EU repeat its effort next time prices fall? It may not. Just how much political will has it taken to pull the market out of its slump? These interventions are not a part of a normal agricultural price cycle and they should not be taken for granted; they may not happen next time.

So, the question is; just how many of the above factors will be repeated and with a regularity that provides the foundations of a well understood cycle? Probably none.

Hence, should one plan their own farming future on the expectation that rise will follow fall? It may not be so wise as the cycle may not be a cycle after all.

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