Weekly market outlook: Jan. 17-21st - inflation, weather, volatility

Chris: Welcome everybody to another episode of the Ag View Pitch. We are heading into a new week, uh, getting towards the middle part of January, or latter part of January I guess, with a short week. We've got Duane Lowry with us. Duane, how's it going today?

Duane

Lowry: Good, Chris, how are you doing?

Chris: I'm hanging in there. So, uh, you know, there's a lot of stuff going around. You had a frog in your throat before we started recording, so if you have a frog, we'll just have to let it jump away here for a bit.

Duane

Lowry: Yeah, let's hope it's just a frog.

Chris: Okay, sounds good. That's for sure. There's a lot of stuff going around. I know some schools have been closed and all kinds of fun stuff. So it just seems like, uh, the black swans keep flying around in circles here and, and stuff. So, um, so I guess what I want to get to today as we talk about the markets in this new week is, is to start out with inflation. Last week, I had a conversation with a guest on that topic as we kind of started the conversation. And, and it just— I'm going to throw a similar question to you. When we go out and we do Profit Manager and we look at the overhead costs, the return to management category, which includes, you know, your groceries, your fuel, your electric bills, your healthcare costs, all of those kinds of things. It looks to me like we're seeing an inflation rate quite a bit higher than what maybe we're being told, for one.

Then the other question I have is you've been around the block 2 or 3 times here, and I mean that lovingly, Duane, and seen a lot of things. So from an inflation standpoint, have you ever seen inflation increase this rapidly and The number I'm seeing, I'm gonna throw it out there, is probably closer to, you know, between about 14% and 17%, somewhere in there. I can't put my thumb exactly on it because I don't have a super scientific way of doing it, but it looks to me like the inflation rate's about twice what we're being told. What's your take?

Duane

Lowry: Well, first of all, we definitely have inflation on the expense side of the ledger. We definitely have expenses, or let's say it this way. It's very reasonable to conclude and realize that inflation is higher than what the Fed tells us because even when we were experiencing, quote unquote, no inflation from the Fed, we knew that we had costs that were going up at different times. So it's not unreasonable to think that they're understating it. So the inflation is real. The costs are very real, and I have no reason to argue with your double-digit ideas of what inflation really is in terms of how people are experiencing it. And you're seeing the actual data. This is not academic on your end. You're seeing the actual data. And if it comes out at 13%, 14%, I'd have no reason to not believe that at all.

Chris: Okay. Yeah, I just was curious. I mean, have you ever seen interest rates in your times going, circling around through ag where we've increased this fast? You know, I, I know in 2012 we, we saw a pretty rapid increase, but I think we're blowing through some of the costs we saw there as I go back and look. I don't know if it's quite adjusted for inflation, but it just looks to me like we're, we're maybe pushing the top end of where we've been before.

Duane

Lowry: Well, in 2012, uh, the inflation experienced by agriculture seemed to be more specific to agriculture and didn't seem to be broad in the entire economy. Now you've got, along with the fertilizer inputs, chemicals, seed, those kind of inflation factors, you also got the labor costs, you know, every single component, the grocery, every single thing that a guy buys is, is impacted because this inflation is now broadly affecting the entire economy, not just agricultural specific. So that would be different than I think 2012. The last time that I recall anything quite like this would go back into the '70s, maybe even going into the '80s when we had high interest rates and things of this nature, but that was all in an effort to fight inflation that had already occurred.

So I think for most people, this is the first time they've experienced this type of inflation that was not seen as a temporary blip or one particular item such as fuel prices or something like that. I think this is the first time a lot of people have experienced this in a broad sense.

Chris:

Clay

Finck: Yeah. The savior is lower interest rates for now. And it looks to me like it's going to be hard for them to go super crazy with raising rates, but That's the big savior, because when we look at the amount of additional working capital we're all going to need, um, going through '22, and a lot of people are just getting that totally dialed in now and recognizing that, you know, wow, we're going to need another, you know, $170 an acre on corn and another $80 an acre on soybeans to, to put this crop in. And you take that times all your acres, there's a lot of additional dollars required going into '22 from from what we had last year. So it's kind of— it's a big deal on the expense side and managing that margin as we look at the markets then as we kind of shift over to that part is really a big deal for sure.

Duane

Lowry: Well, the interest rates, we're told and led to believe and see no reason to not believe it, that they're going to go up and there might be 3 or 4 rate increases this year with some people anticipating more than that. The question about— when we think about interest rates rising, I think most people in agriculture picture back to what happened in the '80s where they went to double digits and things of this nature and really, you know, destroyed operations. I don't think that that right now is on the horizon, and I think that we may see a relatively rapid increase in rates, but maybe we all— would level off at an area 2 or 3 points higher than where we're at now. And maybe that's the most we could go up for a period of time. I don't know, I'm just kind of hypothetically pondering that. But we're definitely going to be going up.

But after being used to, you know, 0% prime for so long, and to see it go up 2 or 3 points from— that's a sizable jump from what we've had penciled in to operations. So it's going to be noticeable, it's going to be felt, and especially, like you pointed out, because the need for capital is going to be greater in this inflationary environment.

Chris: Yeah, it's going to be, going to be one of those categories that return to management category and what we have to spend on overhead expenses. You know, when we, we look at that in general, you know, on, on corn, we're seeing that category up about 21.5%. So it's about $14 an acre on, on corn and well on— on corn and soybeans, it's about the same, about a 21% increase. And so it's, it's a sizable number, you know, when you take it times all your acres, you know, $10 or $13 or $14 on one category and then on every other category makes a huge difference on the bottom line for sure. And, and then gets me to my next point here, I guess, is, is we get talking here, you know, for the short term for this next week and then also looking out as we head towards February and the price discovery period for crop insurance.

Just have you touch on anything that's top of mind that producers need to be watching this next week. You know, as we, as we head into this week and as we look toward February, is there anything just top of mind before I start throwing you questions that are things that, that we need to be watching as producers on the marketing side?

Duane

Lowry: Well, I think the first thing that needs to be mentioned is the fact that the USDA report is now behind us. So whatever amount of unknown factor was associated with that prior to it. That's now gone, and unknowns tend to have a little bit of a supportive influence to price. So once the unknown is gone, you know, that takes away one possible area of support. The other would be South American weather, and, uh, probably going back to mid-late December, South American weather spin has been bullish, and rightfully so. But even a week ago, the weather forecast started to shift, and the trade came in a week ago expecting the markets to be higher because it was going to be hot and dry for the la— all of last week. But they ignored the— they wanted to ignore the fact that there was rain in the forecast.

Chris: All right, so another question, Dwayne, is as we look at the old crop corn then, that's— and soybeans for that matter that are in the bin for those that are still having some bushels unpriced. What's your— what are your comments there? What are some of the strategies you're thinking there?

Duane

Lowry: Well, let's start with corn. A lot of people have been optimistic about corn because of the ethanol industry's rate of consumption, but the last USDA report just last week, we got carryout over 1.5 billion. There's a possibility that carryout number actually goes up. In future reports depending on how exports turn out to be. But with 1.5 billion bushels of corn carryout, I don't think current prices justify that type of a carryout level. The current prices are too high. Now nobody wants to hear their prices are too high, especially if we just had a conversation about inflation. But based on a historical assessment, I think that's— it's a fair and accurate statement to say that current prices are too high.

The other thing that points out the old crop spreads, old-new versus in corn, like the July-December corn spread, uh, has been weakening since about the last week of December, and it's weakened about 30 cents already. And that is typically not a good indicator for, uh, put— not a positive indicator for flat price. It's typically a good indication that flat prices is about to head lower and more than likely this will be a trending lower atmosphere, not just a pullback and a correction and then we'll go back to a higher level. Corn market, again, I'll go back to what I said when we talked about South American weather. Having a major change in weather right now in South America is like having a major change in weather in the U.S. in mid-July. And we all know what can happen when a market is bulled up going into that and then we change that.

I think that's what— how we should look at what's happening with South American weather. I think that's how we should look at what could happen with old crop corn prices. And the table is— I believe the table is turned here to where now all of a sudden the burden is going to be on the farmer to worry about who's going to carry these 1.5 billion bushels of corn that nobody's going to want. And with the market still inverted over new crop, you can rest assured the commercials don't want to own it here. And by the time the commercials get to where they want to own it, or they're going to have to own it because farmers will dump it, whether that's in the spring or whether that's in August, September, you can bet that this— there's going to be no longer an inverse of old crop versus new crop. So I think holding old crop corn here, you're fighting a few different things.

Number one, you're fighting that spread weakening in the old crop versus new crop. You're fighting an inverse that was probably going to go away. You're fighting a carryout level that is not burdensome, and you might be fighting an export outlook that is still, uh, potential to weaken. And, uh, South America's corn production looks like it's going to be— uh, it looks like it still has an opportunity to be very, very large. And you got Ukraine that's been selling corn to China for what little they've been buying so far, and they've probably got 8 to 10 million metric tons of corn more to sell this year than they had last year. So I think the outlook is rather bleak here for old crop, and I think that, that producers— if you ever wonder how you get to a point where you're forced to sell stuff in that July-August time frame, at what turns out to be the bottom of the marketing year.

This is how it starts. This is how it looks. It starts out with carryout that's plentiful. It starts out with a weather change. And I'm very concerned that we've got much more downside risk than upside potential here for old crop.

Chris: What happens to basis in, in that scenario?

Duane

Lowry: Initially, I don't think that is necessarily negative to basis, at least not between now and whenever the farmer becomes a more aggressive seller. Um, and the farmer is probably not going to sell on weakness here, but that isn't a bullish factor. And, uh, it might keep basis well supported. I don't think that I'm seeing anything that makes basis weak here, but let's say you move the calendar forward and, and it's now into the, uh, spring planting period and we've had a good spring planting period and the outlooks look, looks good for whatever reason, then all of a sudden the pressure switches and the producer, if he hasn't been an aggressive marketer, which most have not, and they won't be selling weakness probably, then they are faced with the high input costs. They got bills to pay. They are behind their normal sales pace.

And all of a sudden then the pressure on them to increase sales, um, comes to bear. And at that point in time, then basis is threatened. But it may not be threatened here for a couple of months, but somewhere down the road that is going to weaken basis. But I don't think it is right now.

Chris: Okay, um, let's shift over here as we wrap up. Let's shift over to the '22 crop. Um, You know, what, what makes you comfortable there as far as protecting yourself? You know, if, if some of the things you're talking about plays out, you know, there's a substantial amount of risk as we look at 2022 with where the input costs are at and where a lot of these things are locked in. Any, any certain strategy, things that you need to be— we need to be watching in particular in the next several weeks here as we get into the price discovery period during February?

Duane

Lowry: Well, when it comes to new crop, I think the first thing that needs to be mentioned is just because you have inflation on the expense side of the ledger, there is absolutely zero guarantee that inflation will support your revenue side of this ledger. And that's the first thing. Second thing is, people have mixed ideas of what the acreage is going to be. But let's say that corn acreage is down 1.5 million acres. In '22. That means you're going to have harvested acres of about 84 million. If you have a yield equal to this last year at 177, that would mean— that would produce the same amount that we're going to be expected to consume this year, which would mean that the carryout would remain at $1.5 billion. That's not, uh, concerning.

But the problem is a lot of number crunchers are not going to use 177 for a yield projection, uh, when they start penciling in, uh, 2022 possible yields. They're going to use 180, some are even using 181. And if you start to use numbers like that, now you're going to add $300 million to the carryout. So we don't have a fundamental foundation here in corn looking ahead to '22 that automatically immediately sets you on a bullish footing. In fact, it's the opposite. The marketplace is going to start out with their yields relatively high in the projections and then lower them if they're forced to based on a weather or production problem. So we're going to have a period of time here that until we get a threat to the 2022, uh, balance sheet, I think the backdrop is actually going to look a little bit more negative.

The only thing that's going to support the 2022 prices is going to be that weakening of the spread, which means the front end suffers the most. That doesn't guarantee that these values stay at current values, uh, it just depends— it just means that it maybe won't be the weakest over the next few months. So that's the first thing. In the case of the beans, it's almost the same situation. If you, uh, increase the bean acres by a million and a half acres, which, you know, Ideas are all over the map, but that's, that's a fair place to start. You're talking about a yield equal to last year probably adds, you know, $150, $160 million to carryout. So you'd have to cut the yield in order to maintain the current level of carryout, carryout, and the current level of carryout is still a plentiful one. So you don't have a bullish fundamental footing to start the year in, in terms of projections.

So I think that's a threat. As far as the risk factor that you mentioned, because the input costs are so elevated, there is a massive amount of risk to working capital here in the near term. I don't know how long that would last, but in the next few to several months, there's a lot of downside risk. And in terms of what the producer— his approach should be to possibly attack that, the first thing is to recognize that that threat exists. The second thing is to have some level of respect for that risk. Doing nothing here is probably a greater risk than they've had at any time in the last several years of taking a do-nothing approach. You're talking about Go ahead, Chris.

Chris: Well, what, what percent makes you feel good, Farmer, Farmer Dwayne, if, you know, if you are concerned about where you're at, what strategy, you know, it's not recommendation, but what strategy would, you know, do you feel like is the best thing to take some of this risk off the table? You know, is it HTAs? Is it, you know, using some option strategies, or what is it? You know, because everybody's going to be a little different. Some people you know, like, you know, we've got a number of people that bought margin protection, we've got some other protective devices there. And then with insurance coming up, you know, what, from a practical standpoint, what makes Farmer Duane feel comfortable with a percent covered in some form or format?

Duane

Lowry: Well, my percent of having something covered at these prices would be a lot higher than your audience would probably want to hear. So let me, let me answer it this way. Okay, let me answer it this way. If you go to buy put options, options are very expensive right now, okay? They may not be expensive in terms of volatility, but in raw dollars that a guy is going to spend to get that protection, it seems very, very expensive. So I don't think you can come and do an entire option strategy. And the guy that, uh, wants to have upside opportunity, or maybe he's got a bullish bias, maybe he does believe inflation is going to ultimately end up pushing grain prices higher and, and, and/or their concern is they just don't want to sell it because they're afraid they're going to miss out on something.

If that's the case, then the, the only thing that's probably palatable to that guy is some sort of buy-in of put options. Um, but like I said, that's going to be very expensive in terms of dollars per acre. But I think the right combination here is to, uh, take the approach that having a revenue protection right now is worth more than being worried about what you might leave on the table. And I would suggest that, that a combination of cash-forward contracts, HTAs— I probably personally like the HTAs— I would try to get as much of that done as, as a guy is comfortable with. And on the balance of it, I would look at buying at-the-money put options, which like I said, are already pretty expensive.

But if you're not doing it on all of your acres, but you're doing it on, say you're doing it on 60% of your acres or 70% of your acres or 50%, the rest of it is some sort of an HTA, then that cost overall becomes less. But I would look at buying put options on all of the remaining part of your production. And then wait for the market to do something. If the market were to rally 50, 75 cents, you— all you did was buy the puts. That means you're still making money on that as it goes up. Uh, if the market were to decline by 75 cents a bushel, uh, I would probably look at writing some puts that are then well under the market to try to recover part of the cost of the premium that you paid up front. But I think job number one right now is trying to protect revenue. There are multiple ways to do it. Some have upside reasoning for it. Some are, are more just self-preservation.

Some have more cost to it. Some take away opportunities. Some maintain your opportunities. So there's a lot of different ways to do it. But I think the first— and job one is to recognize there's a lot of downside risk here. Yes, in an overall environment that you don't want to, uh, be in a position to, to take that risk. At least that's my opinion. So I think job one is to formulate a plan and maybe use multiple tools to get there. And what percentage you get there, uh, probably is less important than Let's put it this way. It's most important that you probably do more than what you would normally do. Let's put it that way.

Chris: Well, and to add to that, if you have a real solid foundation on your cost side of the equation, you can establish a margin target as opposed to a price objective, which in my mind does a lot too. It's been a great conversation, Duane. If somebody wants to get ahold of you and talk strategy, what's the best way to reach to get a hold of you?

Duane

Lowry: Best way is just give me a call. My number is, uh, 563-419-1300.

Chris: Awesome, that sounds good. And, uh, it's been a great, great conversation, and, uh, um, just really appreciate your insight. And, uh, people want to get a hold of you, I think it'd be a good conversation with you, Duane, just to kind of talk through some strategies and things, because there's a A lot of challenge out there in front of us. I think there's a lot of opportunity too, but we just got to make sure we keep our head on straight and watch this. So, uh, Duane, thanks a lot for your, your insight. Really appreciate the conversation today.

Duane

Lowry: You bet, Chris. Thank you very much for the opportunity.

Chris: Awesome. Yep, appreciate it. And thanks everybody, uh, for listening, and we will catch you again next time on the Ag View Pitch.