Advice on when to sell the crop is available from many sources: e.g., magazines, marketing clubs, newsletters, and the trading department of the local grain company. Which of these information sources should I use and how should I set up my marketing plan? I’ve discussed these questions previously in
I have a few additional comments to add — especially about using cost of production in deciding when to sell.
Thousands of farmers and traders are trying to profit every day from buying and selling futures and cash wheat. Some of these traders have substantial resources and can quickly spot patterns in the market or important new information. New information is reflected in market prices very quickly, making wheat markets highly “efficient.” For “efficient” markets, future price movements are pretty much random. Consequently, exceptional returns produced by a particular strategy in a particular month or even an entire marketing year are due mainly to luck. Most strategies will produce similar results when the returns are averaged over a ten-year period. For example, if I tell you to sell all your wheat on September 5th every year (you could pick any other day in the year), the average results over a ten-year period will differ by less than 10% from the average returns of any other strategy. The big exception is a strategy that causes farmers to hold wheat too long — so the net return is significantly reduced by storage costs and foregone interest.
The “efficiency” of the wheat market is what makes deciding on a marketing strategy so difficult. Since no one knows how a strategy will work in the future, the only way to evaluate strategies is to check their average returns in the past and, as I argued above, past returns (neglecting storage costs) will usually be similar. The people selling marketing advice or writing magazine articles don’t want to be proven wrong. Hence, they usually don’t provide a strategy that covers all the possibilities. If the strategy isn’t fully specified to cover all situations, its average ten-year returns can’t be calculated. The reason I like the marketing framework developed by Professor Larry Lev is that his rules cover all situations and hence can be tested. He calculates that the average return using his rules is approximately 5% more than selling the crop at harvest. Increasing your returns by 5% over selling at harvest is about as good as you can do over the long-run.
The manager of our grain cooperative, Raleigh Curtis, is a very knowledgeable trader. Raleigh advises farmers to use their cost of production in deciding when to market their crop. First, farmers should decide on the net return they want, expressed as a percentage of their cost of production. Next, they should calculate the wheat price that is needed to give them their desired return. Raleigh has developed spreadsheets that make calculating this target price easy. Finally, farmers should sell their crop when the market price exceeds their target. He also advises checking the market prices being offered for future crop years and pre-selling part of the crop if the available market prices will produce the desired net return for future crops.
I have never understood why cost of production is relevant in marketing wheat that has already been produced. A farmer’s cost of production is very important in deciding what lease terms to accept, what crops to produce, or whether to continue as a wheat farmer. However, once the crop is harvested, production costs are sunk costs and I don’t see how they are relevant in marketing. A farmer wants to use the strategy that will produce the highest average return.
Although I don’t understand its rationale, I believe Raleigh’s approach would produce acceptable long-run results if he will just fix one important deficiency. As I’ve argued above, all strategies will produce similar long-run returns as long as they don’t cause farmers to hold wheat too long and rack up unnecessary storage and foregone interest costs. A farmer following Raleigh’s approach this year probably has already priced most of his crop, so excess holding costs are no problem. However, what should a farmer do during a year when the market never offers him a price that will produce the net return he wants? Raleigh needs to provide additional guidance on this issue.
I happened to have all the data necessary to test Raleigh’s approach for the nine crop years from July 15, 1993 to July 14, 2002. For each year, I calculated the minimum wheat prices necessary to produce 20%, 30%, and 40% returns and then used these target prices to determine when a farmer using Raleigh’s approach would have sold his wheat. For the 1993-4 through the 1996-7 marketing years, the triggers were achieved before the end of November for all three levels of net returns. During the 1997-8 marketing year, farmers seeking a 20% return would have sold early, but wheat prices never were high enough to achieve a 30% or 40% return. For the 1998 through 2001 marketing years, wheat prices were never high enough to achieve any of the three net return levels.
Raleigh has not specified what a farmer should do if prices remain below his trigger price during the entire marketing year. To be able to test his strategies, I assumed that a farmer sold at the end of the marketing year if wheat prices never reached the target. This meant that farmers were holding wheat unsold for long periods during the latter part of the test period, significantly reducing average returns. The average returns for the 20%, 30%, and 40% strategies were 77%, 39%, and 52%, respectively, of the returns achieved by selling every year near September 15th. If farmers using Raleigh’s approach gave up and sold their wheat at the end of November during years when prices stayed below their trigger price, the average returns were much higher — close to or higher than selling on September 15th.
Raleigh needs to provide some additional guidance to farmers using his approach to prevent them from waiting too long and having their net returns significantly reduced by storage and foregone interest costs.