Many producers know that there are certain times of the year which are more profitable than others. After all, agricultural commodities follow seasonal trends that can either pressure or support prices of the goods they use and produce. For example, crop producers often find that the value of their crops can be depressed at harvest time as an abundance of supply hits the cash market all at once. Likewise, dairy producers may find that milk prices tend to be depressed during the “spring flush” season which pressures margins in the early part of the year. Hog production ebbs and flows with pig supply and the weights at which animals are marketed. Hogs tend to pack on weight more easily heading into the fall and winter as temperatures decline and new-crop corn gets introduced into the feed mix. This can pressure the prices received for hogs and thus profit margins in the fourth and first quarters.
Understanding seasonal tendencies can play an important role in how a producer may want to approach managing forward profit margins. When we first started working with producers in the hog industry on margin management 15 years ago, many noted that they were not interested in protecting margins in the summer as that is when they make their money. They were more interested in focusing on the late fall to early spring period when margins tend to be depressed. What we learned however is that “part-time” margin management doesn’t really work. During the spring of 2002 for instance, hog prices dropped precipitously in response to a trade spat with Russia where they stopped importing poultry from the U.S. to protest tariffs imposed at the time on Russian steel imports. This weighed heavily on finishing margins at a time of year that would otherwise have been considered a strong period for profitability.
While it may not be wise to try timing when to protect or stay open on margins, understanding seasonality may help refine the types of strategies to employ in a margin management plan. For example, if you are heading into a period where margins tend to be under pressure, it probably is a good idea to have a fair amount of coverage in place to protect those margins – even if the margin itself may not be historically strong. Moreover, if you understand the reason why the margin tends to be depressed, this may help guide you in the strategy selection process. For example, if I feed livestock and it is currently springtime, I know that the greatest period of uncertainty surrounding crop production is upon us.
From how many acres will be planted to what the weather will be like during germination and reproduction to how many bushels will ultimately be harvested, this uncertainty can lead to increased volatility in crop prices over the summer. Understanding this, I may want to retain flexibility in the strategies I use to protect my feed costs. On the one hand, if there is a significant drought like we experienced a few years ago, I want to make sure I am protected against significantly higher prices. On the other, should we harvest a large crop later this year, I want to participate in the lower prices which could minimize my feed expense and improve my bottom line.
While seasonality can certainly play a role in the decision making process, it is important to remember that the market does not always behave according to seasonal tendencies. In any given year, the fundamental backdrop unique to that period may trump any seasonal pattern. Moreover, historical patterns are based on past price movements so seasonality itself is changing every year as new price activity gets added to the ongoing history. The profit margin itself should be the main driver of any strategic decision to manage forward profitability. Understanding seasonal tendencies can help refine strategies to protect both input costs and output revenues, though seasonality itself should not be the main decision making consideration. Understanding the seasonality of price movements or of overall profit margins can certainly assist in tactical strategy selection and position management over time. This may include decisions to include more or less flexibility at certain times of the year, taking on more cost in option positions, or even increasing coverage levels. A strong understanding of how seasonality affects prices and profit margins can help you make better decisions and give you more control over your profitability.