With summer now in full swing, it is a good time to revisit the topic of seasonality. Many agriculture producers look to seasonal price trends for guidance with their margin management. While seasonality considerations can be an important part of a thoughtful margin management policy, the value of seasonality data has it limits and producers should be aware that it is just one of many factors that influence forward margins. Here we take a closer look at some of the reasons not to place too much weight on seasonality data when making margin management decisions.
History Doesn’t Always Repeat
First, seasonal price tendencies are based on historical patterns and this history is constantly being written. As time passes, these seasonal patterns can change, as new history is recorded and influences the seasonal trend line. In any given year, the expected tendencies for prices to rise or fall at certain times of year may not occur at all. Also, recent history may show that prices are behaving differently than what the longer-term history would indicate.
Second, because seasonality is based on historical price movements, the amount of history used in analyzing a seasonal pattern also makes a difference. Many producers will look more closely at a five-year than a 10-year seasonal pattern, believing that recent history should be given greater emphasis in their analysis. For example, the advent of the ethanol era in the past decade created a new source of demand for corn, which altered long-established historical price tendencies.
While this makes sense at face value, looking at longer-term history might reveal something different. To illustrate this point, let’s compare the five-year and 10-year seasonal tendencies for the December Corn futures contract. Figure 1 shows that when looking a five-year historical tendency of the December Corn futures contract, prices tend to seasonally peak around the week of July 10 before gradually declining into and through harvest during the fall. A corn producer contemplating their marketing strategy for new-crop corn production who relied exclusively on the five-year pattern might therefore conclude that in the absence of a favorable return over cost of production, it might be prudent to wait until the mid-July time period before establishing or extending coverage on their corn price risk exposure.
Figure 1: Seasonality Dec Corn Five Years
2012-2016
However, Figure 2 shows the 10-year historical price tendency for the same December Corn futures contract. This view suggests that the seasonal summer peak for the contract occurs almost four weeks sooner, i.e. during the week of June 12.
Figure 2: Seasonality Dec Corn 10 Years
2007-2016
As shown in Figure 3, this year, corn prices reached a peak on June 9, then declined by 9% as weather concerns abated. They recovered recently on the back of a blistering rally in spring wheat futures, but remain about 20 cents below the June 9 high. While corn producer margins have been and remain negative, a producer nonetheless may have elected to establish or extend coverage to protect against increasing losses from declining prices – particularly at 12-month highs.
Figure 3: Dec Corn Prices for the Year to Date
January 1, 2017 – June 30, 2017
Take the Short and the Long View
So, which is the better time period is to use when measuring seasonality – is a five-year period better than a 10-year? Should we also consider a longer range, such as 15, 20 or even 30 years? The answer is that there is no single time period that is better than another. What is important is to take into account multiple time periods to gain a more comprehensive picture of how seasonality has changed over time. While it may make sense to give one range more weight based on what is going on in the market, a single timeframe should not form the sole basis of a hedging or margin management decision. For example, consider how the PEDv outbreak in 2014 skewed the shorter-term history of the hog market by pushing prices sharply higher than would otherwise have been expected. In the three years since that episode, hog producers would have been well served to take a longer-term view of the seasonal tendencies of hog prices and margins.
Seasonality Should Guide How, Not When, to Hedge
Another common mistake is using seasonality as a filter to determine whether or not to take a hedge position at all. Seasonality is more helpful in determining what type of strategy to use, rather than if a strategy decision should be made. A number of different factors will impact any hedging or margin management strategy decision, and seasonality is only one of those factors. In a previous article, we discussed the issue of looking at how much risk exposure is prudent to carry at any given time. The best starting point is to think about where you want your operation to be on the scale that weighs the tradeoff between offsetting risk and retaining opportunity. From there, seasonality can help to refine strategies that might make sense for that point in the year.
In our corn example, a grower facing negative margins in early June might determine that they would like to prevent against further losses because seasonally the market is at a high point based on the 10-year history. However, the five-year seasonal pattern points to the possibility that the high may not yet have been reached. And, in fact, prices are not high from a historical perspective. Again looking at seasonality data, they may also conclude that corn option volatility is very low from both a historical and seasonal perspective, which indicates that corn options may be relatively cheap. For that reason, a corn grower might opt to simply buy puts to protect against the risk of lower prices.
If you have questions or would like help incorporating seasonality into your margin management decisions, please contact CIH at 1.866.299.9333 or mail@cihedging.com.