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The case for us all having our heads examined

Patrick Patton for Progressive Dairyman Published on 24 August 2017
Anchor

Did you know that when contemplating the price of equipment, clothes, feedstuffs or anything else, you’re battling biases in your mind? Hidden forces are at work against you, and that’s worth a peek inside your head.

Biases are something we’ve written about before. One in particular warrants a deeper look because of our industry’s reliance on price.

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The best way to describe this bias is by taking a trip to a clothing store, where you happen to be shopping for a new jacket. You see a nice one marked down from $89.99 to $59.99. Is it a good deal?

Studies conducted by behavioral economists show your brain will tend to see the lower price as a value. What your mind usually doesn’t see is: The lower price may not be a value at all.

Now let’s drive over to your local elevator and look at things from the opposite perspective: a rising price in commodity markets. For our purposes, we’ll say corn is selling at $3.90 per bushel.

You could fulfill some of your feed needs at this price and not overpay. But earlier in the year, you saw corn at $3.60 per bushel, so you decide to wait. Soon the price climbs to $4.20 per bushel, and $3.90 looks like a good value. Not only does it look good, $3.90 becomes your new price target to hit.

What’s going on in these scenarios?

Behavioral economists would say you’re succumbing to a cognitive bias called “anchoring.” It is a common tendency to rely too heavily on the first piece of information you’re offered. In short, you anchor to it. The anchor is your reference point from which you make decisions. Once the anchor takes hold, your bias is to continually make decisions relative to the anchor.

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In the retail scenario, there’s a good chance the $89.99 jacket really should have had an original retail price closer to $59.99. That higher price was intentionally presented so you’d set your anchor to it. Imagine the original retail price being only $69.99. Not such a value anymore, is it?

In the feed example, $3.90-per-bushel corn was a good value all along relative to 10-year market averages. It likely represented a great opportunity to fulfill at least a portion of your feed needs. Unfortunately, biases such as anchoring compel you to act irrationally where money is involved.

To be fair, you have another anchor when assessing feed and milk prices: cost of production. While this number has to be considered, and it’s always top of mind, commodity markets don’t move based on cost of production. Try to avoid anchoring to it.

Memorable anchors

Think about commodity price anchors from your past. One that jumps to mind for me is the price of soybean meal in 2016. In February of that year, it hit a low of about $260 per ton. At the time, U.S. soybean carryout was projected to be 400 million-plus bushels – the largest since 2006.

We also had ample world carryout and almost no impetus for prices to move much higher. For many farmers, $260 per ton represented a place to drop anchor.

Amid the bullishness, we presented a case for soybean meal futures rising to $377 per ton, yet saw little interest in purchasing meal. A few short months later, the July futures contract for soybean meal topped out at $432.50 per ton.

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Milk prices in the spring and fall of 2014 exceeded $24 per hundredweight but fell dramatically by the end of the year. Anyone who anchored to $24 missed good selling opportunities on the way down.

When prices move fast, it’s remarkably difficult to take action if you’re anchored to a price. This is even truer when price moves within a narrow range.

Forecasting creates anchors

Commodity price forecasting, or outlook, is useful for planning your marketing and feed buying. The chief risk in relying on forecasts is not recognizing their limitations.

Analysts base forecasts on a blend of current conditions, historical prices and an educated guess of future activity. Certainly, analysis gets much more complicated than that. Even so, there is no tried and true forecasting methodology that offers a consistently accurate track record over time.

If prevailing sentiment is corn futures could fall to $3.60 per bushel by harvest, feed buyers likely will anchor to that price and become complacent. Conversely, if popular outlook calls for $4.30 corn at harvest, buyers might start feeling a bit antsy.

Price forecasts inherently create anchors because they generate reference points. That’s not all bad; it helps to start with a reference point when planning. The key is to recognize a forecast is only the first step in planning marketing and feed-buying strategies.

Breaking free from your anchor

The presence of an anchor is by its very nature unavoidable because everything has a price (things like integrity and family notwithstanding). In commodity markets, there is always a starting price, and the price will always change. Still, you can overcome the tendency to rely heavily on the price that sets anchor in your mind.

One way to do so is by not limiting yourself to a single point of view. Seek information from a variety of sources and view situations from different perspectives.

Another approach? Apply some basic math in a way that calculates possible future price scenarios. From there you can see what effect marketing decisions will have on any given strategy and sharpen strategies as needed.

Remember, milk marketing is not an all-or-nothing endeavor. Make incremental sales to increase your average sold price.

Commit to consistent marketing for the life of your operation. Consistency combined with disciplined decision-making will help you avoid anchoring. It can also reap dividends over accepting the market price.

Perhaps most of all, accept that we’re not wired to always act rationally.  end mark

Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore carefully consider whether such trading is suitable for you in light of your financial condition. There are no guarantees that using strategies, consistency or discipline will translate into successful marketing.

Patrick Patton
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