"When You Are Out of Cash, You are Out of Business"

"When you are out of cash, you are out of business", is a truism which should be on the top of everyone's mind these days.  With the bankruptcy filing of Pilgrim's Pride and VeraSun we are witnessing the turmoil and equity destruction which has been brought on by the tremendous volatility in commodity prices experienced over the last year.  This volatility is directly related to (but not completely the result of) government policy interventions, especially ethanol policy.

When financial panic characterizes the global economy, and historic price volatility abounds, even sophisticated and very successful firms sail on very dangerous cross-currents.  One of the lessons in these two firm's hardships is the need to focus risk management on reducing profit or loss volatility, rather than on reducing input cost or output price volatility independently.  Hedging these days must focus on both sides of the profit margin.  If you lock in what appears to be an historically high output price but leave your input costs unprotected, you can easily face an even more historic input cost shock which makes your nice output price look pale.

Many companies (and producers) locked corn prices earlier this year in the $5-$7/bu range to try to prevent purchasing corn at $10 a bushel.  That would have been fine had they also locked the corresponding lean hog futures prices which were in the $80-$100/cwt range for late this year and early-to-mid next year when they locked the corn price.  Many did not. While pork prices may again reach those levels in the spring and summer (as some are forecasting), these folks are feeding this very expensive corn to pigs selling currently in the low $50's carcass basis.  Ouch.

On a related issue, having equity on the balance sheet is not a guarantee that you will have cash to buy inputs either.  Credit is getting tighter in agriculture now and the typical rule prevails: If you don't need credit, there is plenty available to you.  If you do need credit, there is less to none available. 

Collateral values (asset valuations) are changing so fast that a clear reading on equity is hard to estimate.  Translating that risky collateral value into more line of credit to fund losses will be a  challenge for many producers and companies.  The proliferation of subordinated debt (debt financing from feed companies, equipment companies, seed companies etc.) is drying up as the companies offering it are facing their own liquidity challenges and are taking a fortress mentality, holding higher cash reserves.

One good thing is that we should see a distinct reduction in price volatility as a result of the global slowdown.  There will not be the same demand pressing animal feed ingredient stocks to the breaking point but world population is still rising at a break-neck pace.  Agricultural production will very likely be down worldwide in 2009 (except for some isolated food and fiber crops) since livestock production is forecasted to fall and many producers of crops worldwide cannot obtain operating credit.  Since planned production will be less, a short crop in any major production area around the world could set off a new round of trouble by mid-year.  Enjoy the pause, it may be shortlived.