Agriculture and the overall perception of the industry appear hotter than a pepper sprout right now. Well, if one observed the stock market and the real estate market, both were in similar circumstances a few years ago. Let's examine the lessons learned from those industries and apply it to the current state of agriculture.
First, there is no such thing as easy credit. Low-documentation loans, quick and easy credit with low teaser rates and no concern for earnings and income are recipes for disaster.
Paper inflation, whether it's stock prices, real estate or loans, is only paper value until called in. When asset values and bubbles far exceed the capitalized value or profits and returns, the inflated number becomes vulnerable to shocks.
Easy money, or funny money, for investments can quickly inflate an industry and create a bubble. When this money seeks other investments and leaves an industry, it can cause an economic vacuum, resulting in a crash as seen in the stock market and now in Florida and Las Vegas real estate.
Investors involved in an industry early in the cycle are usually the winners. When individuals say we're on a new plateau or at a new normal, this is usually a sign that you are late in the cycle. Build cash reserves and be prepared to stay for the long term, or sell your assets at 50¢ on a dollar.
Producers need to build working capital, particularly during the profitable years. The working capital reserve should exceed 10%, but ideally exceed 25%, of expenses. Next, pay all account payables and possibly prepay principal focusing on debt with the higher interest rates. While these strategies do not guarantee success, they do cushion a short-run economic downturn.
One could almost bet odds that sometime in the next five years, most every commodity is going to be challenged by a liquidity lag — when prices received and revenue decline faster than both fixed and variable costs.
Case in point: The cost of inputs such as feed, fertilizer and fuel will generally decline slower relative to prices as supply and demand adjust lower on the input side. The result will be a cash-flow shortage created by negative profits. Usually, it requires a year or two before the negative returns impact the ability of the business to meet expenses and financial obligations.
On the fixed-cost side, contracts on cash rents also take time to adjust as both the lessor and property owners make a determination of whether the adjustment is a short- or long-run trend.
For years, inexpensive food and feed have been taken for granted in many developed countries. With Washington, D.C., passing the energy mandate, the gold rush is on to meet and exceed standards utilizing commodity crops for energy. Food prices are rising not only in the U.S., but throughout the world.
Grocery costs are up approximately 5% over the past year, while feed costs are up 25%. However, you have to look beyond ethanol as the sole culprit. Rising fuel prices, as well as the shift to more meat and dairy in developing countries' diets, are major contributing factors, with a weak dollar encouraging exports.
Dave Kohl, PhD., Corn & Soybean Digest Trends Editor, is professor emeritus at Virginia Tech. He's published four books and over 500 articles on financial and business topics. You can reach him at sullylab@vt.edu.