What are the Risks in a Sky-High Market?
There’s no question that pulse markets are hot right now. When a Wall Street Journal reporter calls to ask questions about lentils, you know it’s grabbed the public’s attention. The big question though is whether these markets are overheated. And if they are, what are the dangers for marketers?
When it comes to old-crop peas and lentils, our view is that the market is hot but not too hot. The tight Canadian supplies and strong overseas demand are warranting the current high price environment. Trades are occurring at those prices and pulses are being shipped out to fill those sales. As supplies here shrink though, bids sometimes rise higher than justified simply to make sure the contract is fulfilled.
But prices don’t keep rallying forever and when that changes, it reveals risks for marketers. While many farmers have sold most or all of their peas and lentils, there are still some who are holding onto the 2015 crop. That’s not necessarily a bad thing and has paid off well so far in 2015/16. This borrowed diagram illustrates that when prices are extremely high is also the time when the risk is the highest.
In part, that’s because marketers become complacent and assume the market will remain at these levels or even go higher. Or for those who realize the market will eventually turn lower, it’s hard to decide when to “pull the trigger” and sell. That indecision can be costly, especially since when downturns occur, they often happen quickly. And because the market highs are only recognized after the fact, most advisors suggest selling into the rally in increments.
The bigger risk for pulses though is likely seen in the new-crop markets. Extremely high spot bids and record high forward contract prices certainly have the potential to cause farmers to overproduce. As one expression goes, “money is the best fertilizer”. Based on the “buzz” at farm shows and among traders, this risk is greater for lentils than peas.
It’s true that we expect strong export demand for pulses again in 2016/17, but it’s still possible to overwhelm the market. That’s especially the case since farmers in other countries are also getting these same encouraging price signals. And if that happens, the reaction will be rapid and would likely occur even before the 2016 crop is harvested. That possibility should encourage farmers to have prices locked in with forward contracts. In future reports, we’ll examine those possibilities for peas and lentils in more detail.
Another related risk under the overproduction scenario is the potential for existing sales contracts to be canceled if prices drop too far and the losses are too large. We assume that most export contracts are solid, but noncompliance by the overseas buyer always remains a possibility.
There’s one other risk for prices here in Canada that’s not related to pulse market fundamentals. While pea and lentil markets are indeed bullish, prices here have received an extra boost from the low Canadian dollar. As an example, the chart shows that yellow pea bids are $13.00 when measured in Canadian dollars, but if the loonie was at par with the US greenback, the average bid would be just over $9.00 per bushel.
This means that any recovery in the Canadian dollar will weigh on pea and lentil (and other crop) prices. Of course, the Canadian dollar is linked to crude oil and other resource prices. And while we don’t expect a return to a par Canadian dollar, crude oil prices in the Canadian dollar are showing signs of finding a bottom and potentially staging some sort of recovery. That move may not be large or quick, but even a modest recovery in the Canadian dollar would tend to be negative for pulse prices here.
Despite the risky environment, there are ways to manage those risks. This includes locking in pulse prices using forward contracts and talking to a broker about hedging against a rise in the Canadian dollar.
Source : AlbertaPulse