Why is there is high optionality with holding agricultural commodities? There is a high cost of stop-out if you are user of these commodities. This is more likely if there is a low stock to usage ratio. Using the simple scenario presented above, it can easily be seen that even if there is a record harvest, the ending stocks will be below the long-term average. If we have a harvest this year that is close to the ten-year average there will be ending stocks below average.
Even if we have an average or better than average, we will still end with a tight supply situation; consequently, there is a reason to hoard what is available. Prices will have to rise to dislodge hoarding and reduce demand. If there is more demand rationing and better future supply, prices will have to come down in the future. This will cause the forward curve to be in backwardation. Users will want to have the optionality to prepare for the worst, hence there will be a willingness to pay higher for the cash commodity.
Even if we have an average or better than average, we will still end with a tight supply situation; consequently, there is a reason to hoard what is available. Prices will have to rise to dislodge hoarding and reduce demand. If there is more demand rationing and better future supply, prices will have to come down in the future. This will cause the forward curve to be in backwardation. Users will want to have the optionality to prepare for the worst, hence there will be a willingness to pay higher for the cash commodity.
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