In my ECONS101 class, we teach a model of dynamic supply and demand that explains fluctuations in market prices, and has an exploitable business implication where, if a businessperson can recognise the cycle, they can profit significantly from capital gains. The model is best explained (as many models are) using a story. In this case the story goes like this:
Consider a perfectly competitive market, as shown in the diagram on the left below. The diagram on the right will track changes in firms' profits over time. Initially (at Time 0) the market is at equilibrium (where demand D0 meets supply S0) with price P0, and firms are making profits π0. Now say there is a permanent increase in demand at Time 1, to D1 (this is just one way to kick off the cycle, but not the only way). Prices increase to P1, and firm profits also increase (to π1). There are no barriers to entry (this is a perfectly competitive market), so the higher profits encourage new firms to enter this market. Supply increases to S2 (more producers) at Time 2. Price falls to P2, and firm profits also fall (to π2). Now, at Time 2 profits are low and some firms will exit the market (no barriers to exit because this is a perfectly competitive market). Supply decreases to S3 (fewer producers) at Time 3. Price increases to P3, and firm profits increase to π3. As you can see from the profits over time (in the right-hand diagram), a cycle of high profits-low profits-high profits- etc. is created.
Now, as I said, the implication of this model is that you can exploit it for capital gains. If prices (and profits) are high, that is a good time to get out of the market (and sell your firm for a high price). But if prices (and profits) are low, that is a good time to get into the market (since you could buy a firm for a low price). This is what we refer to as a 'hit-and-run' business strategy. Hit the market when prices and profits are low, and run when prices and profits are high.
Now, as I discuss in my ECONS101 class, there are some important things that must be true of a market for this strategy to work. First, it needs to be a perfectly competitive market (which few markets are). Second, the long-term the prospects for demand in this market must be good (or at least, stable), because you want to be sure that you don't buy into a failing market. And third, other business buyers and sellers must not have already realised the profit opportunities in this market. It is this third condition that should be the most problematic, because surely businesspeople can't be exploited in this way?
That brings me to this New Zealand Herald article from last week:
Data just released from the Real Estate Institute of New Zealand shows there were 256 fewer farm sales for the three months to December last year than for the three months ended December 2020 - a 46.6 per cent drop.
Comparing the same three month period the median price per hectare for all farms has risen by 39 per cent to $37,980.
Institute rural spokesman Brian Peacock said sales figures reflected an easing in volumes compared to similar periods over the last three years, with all categories being impacted.
"Logic would suggest that due to the very strong forecast for the dairy payout for the 2021-2022 season and particularly strong prices for beef, lamb and horticultural products, fewer rural properties have been available for sale as landowners - as would be expected - have retained properties in order to capitalise on the current high product returns.
Ok, so farmers are holding onto their farms now, because prices are high. On the surface, that seems sensible. However, based on our model of dynamic supply and demand outlined above, this is the time to be getting out of the market, selling farms for a high price. In terms of the three conditions for taking advantage of this, the market for agricultural products is about as close to a perfectly competitive market as you can get. The long-term demand outlook for agricultural products is good, or at least not falling. What about the third condition? Well, farmers are selling farms when prices and profits are high. And if they are doing that, then it is likely that they will be trying to sell their farms when prices (and profits) are lower.
All of this suggests that there is an exploitable business opportunity here, for anyone who can raise finance (which might be a key constraint, since banks will be less willing to lend when prices are low) to buy farms when dairy (and other commodity) prices are low (disclaimer: this is not investment advice - you should consult a professional advisor before you buy a farm!). Of course, that means waiting until we are out of the current expansionary part of the cycle, and farmers return to selling up.
Read more:
No comments:
Post a Comment