by Adam Juda on Sunday, October 30, 2016
The news is out. American farmers have chosen to destroy 43 million gallons of milk rather than put them up for sale. This was no accident - prices for milk are so low that many farmers would wind up losing money on transportation costs alone.
So how did it all go wrong?
Farmers made the same mistake that many economists do: they assumed that the economy was a static, unchanging thing. It's not; people react to changing conditions and the world is rife with feedback mechanisms.
For a while, milk was a hot commodity. Prices kept creeping up and massive investments into milk production seemed like a no-brainer. After all, it's not like there are many asset classes that are doing well these days.
Unfortunately, many agricultural businesses bet the farm and are now crying over their spilled milk. They invested huge sums into boosting herd sizes. Milk production inevitably rose and farmers excitedly counted their chickens before they hatched.
This massive investment soon created an oversupply of product in one of the most generic of commodity markets (milk). The increasing levels of production couldn't have come at a worse time. Not only is milk facing increasing competition from alternatives (like soy, rice, and almond milk), but there's no sign that the multi-decade trend of decreased per capita demand for milk is anything but continuing.
Even corporate demand for milk should prove concerning for dairy producers. Demand for milk from cheese makers is so weak that the government is stepping in in a pointless attempt to prevent market forces from taking hold. Not only that, but cheese makers are continuously in the news for their experiments to reduce the milk content of their cheeses.
So what lessons can be learned?
If you work in a commodity industry, sudden price spikes often precede a tremendous downturn in price. The increasing prices lead participants to overproduce in a race to grab profits.
Don't fall into the same trap!
Think defensively. Consider selling stakes in commodity businesses when their futures look their rosiest and demand is high. There will always be folks who assume that the good times will never end and are ready to invest their money accordingly. Even if you decide to reenter the market later, you might just be able to buy your assets back at a considerable discount.