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Possibilities of Risk and Reward (PCN Summer 2016) JUN 24 2016 | Consumers and Producers | Pulse Crop News

This article appeared in the Summer 2016 issue of Pulse Crop News.

Chuck Penner

Pulse markets have rewarded growers with historically high prices this past year. One danger in this type of environment is the notion (or hope) that these levels are “a new paradigm” and high prices will continue or even climb further. But as the financial industry fine print likes to say, “past performance does not guarantee future results.” In fact, the grain business has its own saying, “the best cure for high prices is high prices.” It’s not that I’m wishing for lower prices; it’s just normal market behaviour.

To keep a sense of perspective, we like to use long-term charts because it’s important to know where current prices are positioned relative to wide-ranging market conditions. There are fundamental reasons why prices moved to the current highs (at the time of writing), but it would take extraordinary circumstances to push prices to even higher highs. Because most pulse prices are already near the historic tops, the upside potential (the reward) is limited, while the downside risk is considerable.

For peas, the picture is a little different for yellows versus greens. Yellow peas are by far at historic highs, which makes it difficult to imagine what would push prices even higher, aside from a Canadian crop failure. It’s true that two poor Indian rabi pulse crops in a row have created an unusual market environment, but other forces are also at work pushing in the other direction. The price extremes have triggered an acreage response in Canada and other countries, increasing the risk of heavy supplies.

Green pea prices are still fairly strong but are closer to the middle of the long-term range. Largely this is because the extreme highs seen in 2013 did their job and encouraged more production in 2014. Now that prices are lower, especially compared to yellows, acreage and production in 2016 will be limited, opening the door to possible gains. At the very least, the downside risk isn’t as great as it is for yellows.

Current lentil bids are also at or near all-time highs. For green lentils, current prices are far beyond anything experienced before, which clearly tips the balance away from possible reward and toward risk. The only possible bright spot for green lentils is that Canadian growers seem to be favouring growing red lentils, which could limit the expansion of green lentil acres. Farmers in the US however, are definitely responding with increased green lentil acreage, which could trigger a move lower.

Current red lentil bids are just off the record highs but are still near the top end of history, and that means more possible risk than potential reward. High prices have encouraged a big jump in Canadian acres and as long as weather conditions are “normal”, that factor will tip the balance lower.

The charts show spot prices and, for most pulses, new-crop bids are already considerably lower than that. That means the market has done part of its job of responding to the outlook for bigger 2016 crops. The difference between old-crop and new-crop prices already reflects a different risk/reward outlook for 2016/17. Even so, new-crop bids are still historically strong, leaving some downside risk and less upside potential.

It’s not possible to predict all of the possible developments in 2016/17, both bearish or bullish. That said, risk management strategies should reflect the higher odds of a downside risk and the smaller chance of upside potential. The best way to manage this risk is through forward contracting at prices that (at the time of writing) are still favourable, especially with Act of God contracts that eliminate production risk. Even if some forward contracts have limitations and can’t completely eliminate risk, managing risk is the goal.