Agricultural markets are notoriously volatile. Prices often experience dramatic swings in a short period of time. In this interview, Doug Christie, an ex-Cargill agribusiness executive and author of Agricultural Commodities Focus, delves into the forces that drive volatility in the agricultural market, and shares what implications this has for market participants.
Can you walk us through what drives the volatility of agricultural commodities?
Christie: The commodity markets and ag commodities in particular have a reputation for being volatile. One of the key drivers for that volatility is the fact that it's a physical product. So, corn, wheat, soybeans, cotton, they all rely on the earth to be grown. And because of that, you've got vulnerability to weather conditions and natural disasters. A physical product subject to mother nature creates inherent volatility of supply; that physical nature of the product is one of the inherent drivers of volatility.
The other key driver of volatility is on the demand side. So changes in eating preferences or changes in how something gets consumed. One great example we've seen recently is the conversion of ag products from not just food products, but into fuel products. This kind of supply and demand change can create volatility in price movements in ag commodities.
One other key driver for volatility in commodity prices is the fact that supply and demand helps determine price, but price also determines supply and demand. So when prices change, the supply and demand of a product can change. So, as an example, if the price of orange juice goes up substantially, then people can choose not to use or consume as much orange juice as they used to.
That upward price movement prompts the reduction in supply. And so instead of prices going in a one way direction, they come back and correct back to a more normalized level.
I would also say that weather, both short-term and long-term can be a key driver. So when we wake up in the morning and see that there has been a hailstorm in Texas and a large portion of a cotton crop has been damaged, that creates a short-term reaction because a supply that we thought was available is now no longer available to the market. So this physical dependency on weather is a key driver for volatility.
Can you give us a few examples to illustrate this volatility in the agricultural markets?
Christie: The fact that prices can have a big impact on the supply and the demand of an ag product is an important element to understanding the markets. We can look at several different examples of that. So if there's a weather event that damages the orange crop and reduces the supply of oranges, we'll see an upward reaction in price. And then when that upward reaction in price translates to a higher cost to the consumer for their glass of orange juice in the morning, many consumers will say, "I don't need that glass of orange juice." So the demand for orange juice goes down and therefore the price pressure is relieved and prices kind of normalize. There are other products that show that same kind of feature.
One that we see quite often is in the grain markets where if we have strong demand for meat, that creates a demand for soybean meal to feed chickens and hogs to produce that meat. But as the prices of meat rise, people have other choices in their diet and they can substitute away from meat or consume less meat. And as a result of that, the price signal goes back into the grain markets and the AG markets that we don't need as much soybean meal. We don't need as much corn to feed livestock, and therefore we see a reduction in demand for those products and a price softening as a result of that. That cycle of supply and demand plays out across lots of different commodities.
It can even play out between two related commodities. An example of that might be something like butter versus vegetable oil. So when dairy prices are low and butter prices are relatively low, people might use butter as a cooking oil or butter in food recipes. But when dairy prices get high, people may shift away from butter and go to vegetable oils like soybean oil or canola oil to serve that same purpose as a cooking fat or an oil ingredient in a recipe.
It's not just the absolute price of a single commodity, but the relative prices between commodities that can influence prices and influence supply and demand for each particular basket of goods.
Would you say that volatility in this space is higher compared to other sectors of the market?
Christie: I think so. I think one of the really interesting things when you look at AG commodities over a long spectrum of time is undoubtedly we're consuming more corn, more wheat, more sugar, more vegetable oil, more of every ag commodity than we did 20 years ago, 10 years ago, or 50 years ago. Yet the price of that commodity has not moved in a straight line direction. Prices have moved around a fairly narrow range across a period where both the supply and demand of the product have changed dramatically. So that's really a testament to the fact commodity markets are in a sense, organic, in that high prices create supply, high prices curtail demand, low prices create demand, and low prices curtail supply.
You have this feature in commodity markets that the cure for high prices is having high prices, the cure for low prices is having low prices, and that kind of inherent tension in the market creates volatility so that over a long span of time, we have prices moving up and moving down and not moving in a straight line direction. So that's why the price of corn today is not a hundred dollars a bushel, it's $6 a bushel, similar to the price that it might've been 30 years ago. So that's really an interesting feature and facet of commodity markets that they have this self-regulating tendency and that creates short-term volatility in the markets and long-term health by managing supply and demand.
What are the implications for traders?
Christie: Because ag commodity markets have a lot of volatility, that creates both opportunities and risks for market participants. I think the volatility creates an opportunity in that there is price movement. People that are looking to trade in a market, one thing that they need is movement and price. So an opportunity to enter and exit markets profitably. And because ag markets have a lot of volatility and a lot of price movement, it provides that opportunity to market participants. I think one of the challenges with that is that volatility can create some surprises and it can create some swings. So as a participant in markets, you need to be aware of the potential for volatility, aware that markets can move sometimes quickly, sometimes violently, and be prepared to weather that storm or sit out that market volatility if you don't have a strong or informed view about the market.
There is a perception that long-term market participants are better equipped to do that. And to some extent, I think that's true if you have a proprietary stake in the business or some knowledge based on your own business. In other words, if you're a farmer and know what's happening growing your own crop, that can help inform your decisions about what prices might do in a way than someone who isn't growing a crop and doesn't understand it as well doesn't have that advantage. But at the same time, being able to enter and exit markets that are moving does create opportunity for people that want to participate and be a player in ag markets, even though they may not have a physical stake in the business.
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