Lessons Learned from 2016

As a new year begins, we take the opportunity to reflect on the past 12 months and learn from what happened in the markets. Below are four important lessons that 2016 taught (or reminded) us.

1. Markets are still cyclical.
When margins are strong, it’s easy to get complacent about managing margin risk and forget that the market moves in cycles. In fact, in an improving margin environment, fear of missing out on additional margin improvement may tempt people to forgo executing margin management strategies. But it’s still true that “nothing cures high prices like high prices.” Strong margins provide incentive for producers to expand their production – and weak margins signal producers to contract – pulling margins in the opposite direction. The lesson is to expect that what goes up will eventually come down, and to have ample coverage in place to protect your operation from the inevitable swings.

2. Have a plan.
While it is easy to understand why cycles exist, it is much harder to predict when they will turn. For that reason, it is helpful to be proactive about managing margins with a sound and thoughtful plan. Your plan should provide guidance for the right action to take in a variety of margin environments and price situations to strike the right balance between protection and opportunity for your operation’s specific goals and needs. Thinking through your alternatives in advance and from many different perspectives can remove a lot of fear and stress that can come with making important marketing decisions in a challenging or fast-changing environment. A plan can also provide you with greater confidence in the decisions you make, so you avoid second-guessing yourself.

3. Hope for the best, but prepare for the worst.
The goal of margin management is not only to protect attractive profit margins, but also to reduce the effects of unfavorable markets. That’s why a comprehensive margin management plan will include a contingency component. In addition to triggering coverage at certain margin levels that are attractive by historical comparison, your plan should provide guidance for minimum coverage in case margins never reach those levels. By addressing this worst-case scenario, you help protect your operation against potentially devastating losses.

4. Volatility can be both friend and foe.
Many agriculture producers think of volatility in negative terms. To be sure, without a sound margin management strategy in place, big price swings can wreak havoc on cash flow and budgeting – and could even wipe out an operation. That’s why the goal of most risk managers is to compress the volatility of returns. If the market moves against you, strategic hedging positions can reduce the negative effects by allowing you to get a more attractive price than the current market. By the same token, when the market moves in your favor, margin calls will mitigate the net positive effect on your margins.

However, while the goal of margin management is to achieve more consistent returns, the reality is that volatility isn’t all bad. In fact, for savvy margin managers, price volatility presents opportunities. Proactively managing both input costs and output prices means you have more than one way to protect your net margins. Each time prices change, you may have an opportunity to capture an incremental gain by making a position adjustment. Volatile markets with frequent and/or large price swings simply present more of these opportunities. Over time, thoughtful adjustments following market movements may allow you to achieve a better margin position, with stronger protection, more flexibility, lower cost or some combination of all three.

While no one knows when and how cycles will turn or prices will move, it is safe to say that market volatility is here to stay. When markets start to move, it makes sense to consider whether and what kind of strategic adjustment would help you get closer to your margin objective.

If you have questions or would like help incorporating these lessons into your margin management plan, please call 1.866.299.9333.