As I sat down to write this post, I was reminded that to be a good blog post, it needs to be pertinent to current events and timeless. This sounds contradictory at first. However, as I thought about it, using a CURRENT market event might be a good idea to illustrate an old, tried-and-true commodity truth.
If you have listened to or watched any of our podcasts, webinars, or YouTube videos, you have likely heard me say, “The best cure for high prices IS high prices.” This statement is cliché in the commodity biz, and to quote an old friend, “It’s only a cliché because it is true.” Why is it true? Very simply, high prices encourage more production because high prices can be very profitable for producers AND discourage demand. High prices tend to do that, right?
Now, different commodities often behave differently to high prices. On the supply side of the balance sheet, grain & oilseed crops like corn, wheat, and soybeans can respond much more quickly to supply disruptions because we are never more than one crop cycle away from farmers planting more acres to the short-supplied crop the next time they plant. Shortening the supply/production cycle even more is the fact that farmers in the southern hemisphere can respond by planting more acres to the short crop in just 6-months. For example, if we have a poor corn crop here in the U.S. due to poor weather, Brazilian farmers can plant more acres in response to the higher prices caused by our bad weather. We have the next corn/soybean/wheat crop in 6-months. Tree crops, like coffee, OJ, palm oil & cocoa can take much longer because when you plant a new coffee tree, for example, it won’t produce any coffee beans for a few years—more on that in a second.
Another difference is demand elasticity. My favorite example here is coffee. I don’t care how expensive it is; I’m NOT going without coffee. In fact, globally, when coffee prices rise significantly, the effect it has on demand is minimal. Other products may have more significant demand responses to higher prices. This brings me to the current example I wanted to use to make the broader point: orange juice. Now, oranges are a tree crop, meaning we don’t plant new seeds in the ground every year. To fix a supply problem, which we certainly have right now, thanks to a couple of hurricanes and “greening” disease in many of our trees here, farmers plant new trees and then must wait 3 to 5 years to start getting fruit from those trees. As you can see, fixing supply can take a while.
Because while supply takes a long time to “fix” for tree crops, demand is the only lever available to balance supply and demand. But here is the essential takeaway from this post! Demand destruction, due to the high prices, often takes a long time to see. Market prices always react IMMEDIATELY to supply problems. In the case of OJ, prices were already moving higher just BEFORE the first hurricane hit. We knew the hurricane was coming and the market started to price in that risk. After the hurricane devastation was known, prices continued higher, trying to get to that price high enough to ration some demand. But where is the demand destruction? It NEVER shows up as fast as the market expects. Why? Because those companies that use OJ, restaurant chains and manufacturers have a pipeline of products coming at them that usually includes forward contracts for some future supply needs they have. Then, new menus must be printed and on and on. It takes a long time to raise prices. In other words, while the disaster happens today, consumers usually don’t see the higher prices for many months.
By the time the consumer sees the higher prices and changes behavior, in this case, they switch to drinking some other type of juice, market prices have gotten so out-of-hand that the big drop ensures. A wise, old commodity analyst friend of mine likes to say, “Bull markets take the escalator up and the elevator down.” Below is a chart of OJ futures. The elevator ride is pretty easy to see.
I hope this has been helpful!
Dave Reeble, President and Founder