Episode 1: There’s an equation behind volatility

Another week into the coronavirus pandemic, Rodney Connor and Gabe Sheets-Poling look closely at the market’s volatility, squaring it up to past major movements with Hurricane Katrina and the 2012 drought. The two talk about whether they’re seeing more farmers hold or sell their crops, why it’s important to set a plan before moments of panic, and how correct grain marketing strategies are more like an inside-the-park home run than knocking it into the bleachers. 

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Transcript

Rodney: So the market moves, up or do, either way – but when we wake up, it seems like the market is noticeably different than it was the day prior. 

Gabe: So it’s back to normal?

Rodney: Yeah, yeah. When I first started in the industry, it was kind of like a penny or two was a big change, back then. But for the bulk of my career, I mean: three, four, five cents in corn every day is kind of normal. And we haven’t seen that in a long, long time it seems like. 

Gabe: Back then it was if you sold above three bucks you felt like a hero, right? 

Rodney: Yeah, that’s true. Probably percent of movement, it’s about the same – two, three cents of two dollar corn, two fifty corn?

Gabe: But we’re also not having any conversations about LDP

Rodney: Oh man, LDP. The first year I started in the grain industry, on the river, was the year Katrina hit – Hurricane Katrina. Corn went to – our basis was a dollar ten under, corn futures two bucks, right. So I’m literally quoting guys 90 cents for corn.  And most guys are, like, hanging up the phone yelling at me as this is happening. 

And then this one guy – I won’t mention his name here – he calls me up and says, “Hey, what’s the price of corn,” and I said, “90 cents,” squeamishly into the phone. And he’s like, “Oh yeah man, keep pushing her down, keep pushing her down.” And I was like, “What are you talking about?” And he goes, “LDP. I’m playing the LDP game.” And that is the day I fell in love with the grain industry right there; it’s not what it seems.

Gabe: There’s almost always one than one piece to the story, right? You see one thing and it’s confusing and there’s something else going on. When we think about the price action returning to normal volatilities, normal market movements, it’s interesting because it reinforces how important all of those plans that people put in place are to just keep following. Right? 

It’s hard every year when there’s not a lot going on to remember, “Oh yeah, something could come smack the market one way or another.” Like you said, like in the early 2000s, the markets sucked. Late 90s, early 2000s, up until about 2005. It was a couple cents a day. If you sold three bucks you felt like a champ. And then you found guys playing the LDP game, or whatever other hustle was there. 

Rodney: You talk about volatility, when most guys think about volatility, they think about upside swings – that’s fun, that’s the more fun side of volatility. But Hurricane Katrina was for sure volatility to the downside. It was one of the incidents where the market crashed and we saw and increase in volatility – I don’t know, you were into options back then: were options prices crazy high? What was the feeling?

Gabe: They actually went down. Volatility is an interesting thing in terms of markets and options prices. Lower prices generally mean lower volatilities. Now, obviously that’s not the case today. But when you think about what happens in times of panic, rarely do people freak out about there being too much corn. People panic when there’s not enough. So the biggest volatility swings tend to come around moments of peak uncertainty, which are really around lack of supply. 

And so, back then vols certainly were up, but they weren’t up as big as they were, say, in the financial crisis or in the 2012 drought. And comparing that to today, obviously markets are lower but we are seeing a material increase in expected volatility. Which the market thinks is still coming. It doesn’t 100 percent line up, but that gives you an idea about where the concerns are from the bigger market perspective. The world doesn’t really panic at low crop prices

Rodney: That’s interesting. So volatility actually equals uncertainty plus panic. There can be uncertainty around a big crop, but who cares. Uncertainty around a small crop is a much different story.

Gabe: That’s exactly right.

Rodney: Or uncertainty around a large crop during a pandemic equals higher volatility.

Gabe: It’s the panic side of the formula because of the macroeconomic impacts. It’s not really a concern around supply. We’ve had large crops for the last number of years. There’s plenty still being carried out, so there’s not really a supply crunch. It’s really a lack of understanding what is all of this other stuff going to do to overall demand. We’ve suddenly seen cattle prices pop up quite a bit relative to where they’ve been. Corn has been holding pretty strong, with China coming back in. We’re seeing beans come on. Obviously today’s market movement, which is on March 24, for those of you keeping score, the indices are up. So the overall complex brings everything else up with it. It’s fairly supportive. That’s despite what we’re hearing today about quite a bit of ethanol grind being slowed down or closed in the next week or two. 

Rodney: I’m just curious like, the average farmer is sitting here today, from a behavioral standpoint how is his brain contemplating what’s going on here?

Gabe: Well, the average farmer is a human. 

Rodney: Turns out.  

Gabe: Well I don’t know a lot about farming, I know a lot about humans. We probably heard when you were in grade school, like we all did, about fight or flight. And there’s a big third one: freeze. The actual most reasonable reaction from panic is to freeze, not to run or fight. It’s to stay still and hopefully no one will notice. 

And so when this kind of chaos enters the market, whether it’s in the crop prices aren’t producing themselves. Or the overall market – like the coronavirus event – most folks default reactions is to freeze. And just not make any decisions. Because it feels like I’m always going to tell myself, if i put myself in a farmer's shoes, I can give you a lot of reasons why the market is going to go back up. We're going to see more demand for animal protein. China seems to be fine. You can pile on the stories in a recovering market about why commodity prices may go higher. And that’s true most years. 

It’s easy enough to make up the reasons to not do anything and then the overall layer of uncertainty the coronavirus is creating in a market we haven’t seen before, with dynamics we haven’t seen before. It just layers on and reinforces my instinctually reaction to do nothing. 

Rodney: Yeah. And that’s easier, I assume, than the default. It feels comfortable to do nothing. Is that accurate?

Gabe: It’s easier to do nothing because then I didn’t make a decision. So I don’t have to feel bad if I sold some grain today and then the market goes up tomorrow. Because in that case, if I made a decision to sell, and the market goes higher, then it feels like I messed up. If I don’t do anything and the market goes down, obviously that hurts the income on my farm, but it doesn’t feel as bad because it doesn’t feel like I made a decision. 

Because my starting position is I grew some corn, I’m long against the market, that’s just kind of how it is. My decision was to farm; my decision was not to get long on the market. That exposure does not carry the same emotional pain as when you’ve made a decision to price. Have you been seeing guys acting much different than that?

Rodney: You are describing exactly what I’ve seen, by the way. I’ve had a few guys calling me up and say, “Hey I’m out, I want everything gone.” They’re essentially hitting the panic button, reacting in some way. And for sure those guys that say, “Hey, I don’t want to talk about it, I just want to hunker down for a couple weeks and see what this market does.” 

Especially this time of year those guys working on the planter, it’s easy to be distracted and go think about something else. It is uncomfortable to talk about grain marketing for most farmers. As I sit across the table from farmers and talk to them about marketing decisions, you can see a visceral response to, “Hey, you need to make a decision here. We should talk about what that decision should be.”

One thing you’ve talked to me about a lot is how advantageous it is to make that decision ahead of time rather than when Rodney is sitting across from the table from you saying, “Hey, I think you should sell.” 

Gabe: Right, or the market’s moving way faster than it has in a while. Making decisions in those moments is hard, it doesn’t really matter who you are. And even when you look at the big grain traders having come from those worlds, rarely are the best decisions made in the moments of peak stress. The best decisions are made when people have the time to take a look and have a view and consider a whole bunch of things. 

And the reactions that we have in those moments of stress often aren’t really driven by logic. Sometimes they work, sometimes they don’t, but you keep bringing up the word ‘panic,’ whatever it is that drives an urgency that you don’t have control over often leads to a level of stress that sets you up to make illogical decisions. Sometimes it may be the right decision – and that’s almost worse. I worked with a guy for a long time that said, “The worst thing that can happen to you when you go to Vegas the first time is winning.”

Rodney: That’s exactly right. That totally rings true.

Gabe: If you’re thinking about your grain marketing and – pick a year. It was the wrong year that year to sell during planting and you get to harvest you feel like a schmuck, you say, “I’ll never do that again.” Even though we know most years, selling a good chunk ahead of harvest is the right thing to do. One of the worst things that can happen is when you let your grain marketing fall by the wayside, sell it at harvest and it goes really well. It’s pretty easy to feel good about that.

Rodney: That takes me back to 2012, obviously. The big drought. I collected checks, so being a grain guy, I’m really good at mailing checks, but I’m not really good at collecting checks. People call me a salesperson; I don’t want to sell anything. I don’t like collecting checks from guys. But in 2012 it was this weird situation where the market was so much higher than the crop insurance guarantee price. It was so profitable. Guys weren’t going to raise 200 bushel corn in my area; they thought they’d raise 80 bushel corn. But at six dollars or seven dollars, 80 bushel corn was a big deal. That was going to pay the bills. So in a lot of cases we got guys oversold. And I’m not talking 200 bushel and raised 80. I’m talking we sold 80 bushel and they raised 76. So we had to buy all those contracts and that wasn't fun. 

And even worse than that was their neighbor who didn’t do anything, who cashed in at eight dollars on all that crop and were like, “Oh man, you went through all that disaster, and here you sit. A hundred bucks less an acre.” 

Now looking back, getting to play Monday morning quarterback eight years later, I get to see those guys who went through that pain and managed their risk sitting much better today from a financial standpoint because they took advantage of 450 futures last year during the spring, when everybody else was saying, “Eh, no way, I’m not doing that again. Last time that happened I got eight dollars for my corn.” 

And on the flip side, those guys that did really well, I watched them miss out on some real opportunities last year and are kind of struggling based on that, still sitting on old crop.

Gabe: It’s an interesting dynamic, since when I explain farming to folks: when people get into farming, they get into farming to farm, and they’re probably going to farm almost until they die. It’s a long term decision. You don’t get into here lightly. And certainly, if you stick around, you have the benefit of being able to look forward not just days, or months, but years, which is not a usual situation for a human. 

For most of us, if you think beyond three months, that’s never happening. I’ll agree for a lot of things to happen three months from now, because my brain is like: sure. It’s an interesting dynamic where – especially for guys who have been around for awhile – they can have a really long memory and think really far forward. 

But a lot of times we make decisions around grain marketing based on what happened sometimes literally, but figuratively yesterday; we carry that pain with us. It hurts the decision-making we do going forward. The core principles we think about when talking to someone about a grain marketing plan is really about stabilizing income and to your point: you don’t want to sell anything, I don’t want anybody to think I’m telling them to sell the high. I don’t know how to hit home runs, I know how to hit singles, doubles, maybe a triple here or there – and if I’m lucky, we will get an inside-the-park when somebody fumbles the ball. 

That’s what it’s about: consistent, solid decision-making to set you up in a position to hopefully not only take advantage of seasonal trends and well-worn market behavior, but also so you can plan revenue for your business going forward. Think about costs, expenses, and match up that longer term view that you can have as a farmer with slightly longer view on prices and how those things will impact your farm operation.

Rodney: That inside park is such a perfect way to put that, right. If you hit a home run, and you do the correct grain marketing, it’s going to look like a series of crazy mistakes. It’s not going to be 100 percent six dollar corn sale, or whatever. It’s going to be, “I don’t know, that feels pretty good, that’s decently profitable. That’s okay.” And then, all of a sudden, the market tanks, and now you look really profitable, because that’s what it is. Essentially: how does a farmer get away from his sales to the current market?

Gabe: I don’t know that they do. It’s one of the difficulties when you think about behavioral economics, and those behavioral models around how people experience prices. You can learn as much as you want about those things, but that doesn’t actually stop you from feeling the emotions. So, when I put on positions and it might be an amazing position and net made however much return – when it gets to the end, I’m going to default look and go, “What if I made the perfect set of decisions? What would that have looked like?” I don’t know how to avoid that. 

That’s why I have to put myself in a position to not make those decisions in the moment because that’s actually really stressful. Trying to pick the high or pick the low is a recipe for continual disappointment. And so the emotional part of me is always going to look back and go, “What was the best that could have happened?” Because anything under that feels like a failure. The intellectual part of me needs some space and then can explain to the emotional part, like, “Hey, you followed the right process. You’re comparing against this thing that is actually irrational cause, by the way, one person did it by accident because they got confused about what number they dialed.” 

Realistically, let’s pick a better benchmark. Maybe it’s an average, maybe it’s a series of decision points that you might have made. But you have to accept the fact that there’s always going to be probably some big bear in front of you that you could compare to that will never let you feel good about the decisions you’ve made. You need to give your brain the space to have the intellectual set of thoughts and processes to say, let’s evaluate this in a more realistic way. While I still feel the pain, by default, I tend to look at averages as benchmarks rather than single moments in time.

Rodney: Back to that in-the-park reference: The only difference between an in-the-park home run and an out is a twenty-five cent move around October 1st. Twenty-five cent move to the upside feels like, “Man, I really failed,” but a twenty five cent move to the downside feels like – 

Gabe: I’m amazing. I’m a genius.

Rodney: I’m the greatest grain marketer of all time. That’s awesome. 

Gabe: And by the way, I’m going to tell everybody when it sold and it went down but I’m not going to tell anybody about when it sold and went up. 

Rodney: Never happened, never heard a guy do that, that’s right.

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