Absolute versus Relative Risk


The current market environment appears very opportunistic.  It seems that few weeks goes by without some record being broken with respect to prices.  As I travel around and gauge producer sentiment, many are optimistic about the future.  This goes against every intuition I’ve ever experienced, in that producers are typically pessimistic about the future.  Cattle output prices are strong and seem to be signaling expansion.  However, as Dr. Tonsor highlighted last week, a full-fledged beef herd expansion continues to be tempered.  First, cull cattle prices remain strong in a similar vein as calf prices.  This phenomenon is in competition with expansion signals.  Second, any expansion will come at a cost.  Whether heifers are developed on the farm or purchased, these replacement females are/will be costly.  These costs will have to be absorbed by the producer or financed by an outside source.  Third, with these record prices comes an increased level of market risk, which creates its own set of issues with respect to the high costs of expansion.

I think everyone would agree that increased market risks are present when compared to historical levels.  However, as others have pointed out, the data do not indicate that these levels are as extreme as believed nor are there signs to indicate the risks are getting larger.  This is true in the relative sense.  For example, a 5% increase (decrease) of a $150/cwt price level is different from a 5% increase (decrease) of a $100/cwt price level; respectively, these are +/-$7.50/cwt and +/-$5/cwt.  The point is that the absolute price risk for most all agricultural commodities has increased whereas the relative price risk has moved only moderately higher or even steady due to the higher price level that these markets are at.  This is important for producers who are in the market only a few times per year (i.e., cow-calf producers, winter/summer backgrounders, etc).  As opposed to a firm that is in the market multiple times in a month or few months, an unfavorable absolute price move for once- or twice-per-year marketers could put their operation in jeopardy despite the increasing output prices.

Source: Livestock Marketing Information Center, In the Cattle Markets Newsletter (link)

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