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Top tools for first-rate market plans
No one expected the record-breaking streak of corn and soybean prices to last forever. You know better than that. But 2014 is shaping up to be a time to hit the pause button, put current economic conditions into a historic context, and focus on an emerging set of factors that will impact prices and profit margins into the future.
So, get ready for a reality check. Stay flexible and move in sync with the markets as they head in the direction of a brave new world of modest expectations.
“Don’t compare markets to last year,” says Chad Hart, Iowa State University ag economist. “We’re used to seeing home runs the last few years. Most of us are more singles hitters. We’ve got to go back to tried-and-true market rules. Go back to looking at margins and making a profit when the market offers it. The market only offers it about half of the time.”
The unpredictable and risky nature of farming was on full display during the 2013 growing season. Following on the heels of the devastating 2012 drought, many producers slogged their way through the wettest spring planting conditions in 119 years of Corn Belt history.
After only a couple of good days in April, farmer Dale Hadden of Jacksonville, Illinois, who farms with his parents and brother, was out of the field until May. “We were rained out May 16 and couldn’t get back until June 8. That’s when we went ahead and planted corn,” he says. “Then we replanted corn later. We had three planters going on beans and ran nonstop to June 18. We had 4 inches of rain in three hours, beating seed into the ground. We replanted beans, too.”
Then the faucet shut off. Crop conditions slowly morphed into a drought tempered, at first, by an unseasonably cool July and finally overtaken by intense August heat. Average precipitation across Indiana, Illinois, and Iowa during July and August was possibly the third lowest since 1895.
By early September, uncertain crop prospects clouded the market horizon, as corn and bean prices seesawed over kernels of news. Then scattered rain fell on late-maturing crops across the eastern Corn Belt. Bolstered by bin-busting yields harvested outside of the Corn Belt, the stage was set for a September 30 report signaling a rebuilding of corn stocks.
“We could see potential for a very large corn crop hitting the market,” Hart says. “The report indicated basically two different Corn Belt crops: one in the eastern part and one in the western part.”
The threat of frost damaging immature soybeans, along with a tighter market with limited carry, weighed on the market. “Bean prices held up relatively better than corn,” Hart says. “By late September, the market was front-loaded for beans. That will begin to reverse.”
Set against a backdrop of potential climate-change headlines, today U.S. agriculture is confronting three other converging realities:
Global competitors chasing ramped-up commodity returns.
Export demand destruction triggered by an era of tight, high-priced stocks.
A plateauing ethanol market.
“We’re not seeing a full recovery of corn demand, and it will hold prices down,” Hart says. “We’re seeing increased pork and poultry export demands that could help push us as we go down the road. The market still is offering profit opportunities.”
Preharvest sales slow down
Preharvest sales sank to historic lows in 2013. Some farmers felt that they had made a mistake in selling new crop early last year. Spring downpours, drown-outs, and acres of prevented planting caused others to lose confidence in how many bushels they’d raise and when crops would mature.
One Illinois elevator manager reported only 500,000 bushels priced going into harvest, compared to 2 to 3.5 million in recent years.
“I did one of the worst jobs of marketing in some time,” says Hadden. “To get started, I sold a small percent of corn a year ago for fall delivery and sold a little more over the winter. Then I froze during planting delays. I thought I might have 30% prevented planting. If I take out those acres, it affects my percent of marketing.”
The good news for Hadden and other eastern Corn Belt producers was scattered, timely showers in July and August. He was pleasantly surprised to see the yield monitor tick up to 180 to 200 bushels of corn planted on his hills and on black ground.
He sold some corn for late-September delivery for 70¢ over the basis. Within 10 days, it had dropped to 55¢. He ended up with 65% of his crop sold by harvest, instead of his 70% goal. “I’ll dry the rest of the crop and put it away for a postharvest rally,” he says. For corn, he’s looking at deferred contracts in January and March. “I’ll put a hedge on it and see what basis does,” he says.
In early September, he sold some beans for $13 per bushel. “There’s no need to put beans away when I can sell for that kind of price,” he says.
Incremental sales with Basis moves
As you round the last lap of a long drawn-out harvest, the outlook isn’t all doom and gloom. Row-crop farmers are cushioned by stronger balance sheets and fortified by ample on-farm storage. Basis will be their trigger to sell.
With a late, possibly wet, very variable-quality crop, the storage stakes are huge. You may take a second look at the opportunity costs of foregoing sales to pay off debt.
The majority will store corn and search for ways to protect the future value of the crop.
“Realize that holding cash with no plan is your greatest risk,” says Al Kluis, Kluis Commodities, Wayzata, Minnesota.
He urges you to study the alignment of the futures market to evaluate risk. For instance, July 14 corn is trading about 30¢ higher than December 13 corn ($4.50 vs. $4.80).
“That carry, plus potential basis improvement, makes holding onto some cash a logical decision,” Kluis says. “That’s a nice return to storage. There are a lot of unknowns, but the odds are good that cash prices will improve as we look at spring and summer in 2014.”
However, Kluis points to an opposite scenario for soybeans. “The July 14 soybean contract is trading at a 50¢ discount ($12.70) to the January 14 contract,” he says. “Unless something unexpected occurs, cash prices probably will drift lower over time. That makes holding onto cash more risky.”
Add to this a potentially large South American soybean crop soon. “It’s much easier for farmers to decide to sell beans for $13 prior to harvest, compared with selling $4 corn,” Kluis says. “Corn prices may not seem high enough, compared with recent years, but with normal weather next year and larger inventories, 2014 prices may be significantly lower. Hope isn’t a marketing plan. You need to be proactive.”
Kluis offers the following three strategies to help you play catch-up on marketing and to cut the risks of carrying corn into 2014.
Use a hedge to lock in at May or July futures prices, if you can do it at breakeven or better.
Buy a put option. If the market goes lower and you hold the crop in the bin, you’ll have price protection on those bushels. Yes, you’ll pay a premium for it, but think of it as a crop insurance premium.
Contract with the elevator to sell your grain. Let the elevator buy back a call option. It provides you with the majority of cash needed. One of two things will happen:
- If the market goes up, the call price increases in value. Then the call option can be sold and added to the selling price.
- If the market goes lower, money is lost on the call option. What’s lost is probably less than if you sit with unpriced grain in the bin.
Farmers have more marketing tools at their disposal than ever before, Hart says. “It comes down to what you want to pay: 3¢ to 5¢ per bushel for a more formulaic tool, or expect to pay 15¢ to 20¢ per bushel for more management. It’s a risk/return trade-off,” he says.
If you are confident in your marketing skills and more comfortable with risk, Naomi Blohm, Stewart Peterson, West Bend, Wisconsin, offers the following three marketing strategies.
Buy a March at-the-money put. “You would have until February 21 to decide when to take the corn out of the bin,” she says. “During this time, there isn’t a margin call risk, and you’d have unlimited upside cash potential while establishing a price floor for unpriced cash bushels.”
If you have a higher risk tolerance and can manage potential margin calls, buy a March at-the-money put and, at the same time, sell a March out-of-the-money call. “The advantage is that it protects unpriced cash bushels and gives you more leverage if the market goes down,” Blohm says. “The risk is potential margin calls if the market goes up.”
“If you want to sell at harvest and not store corn, buy an at-the-money March call and, at the same time, sell the out-of-the-money March call,” she says. It’s called a bull call spread. “The advantage is if the outlook for a higher price is iffy, it’s a cheap way to re-own. No margin calls. You don’t have a lot of muscle power if the market goes higher, but it gives you a lot of confidence that you’ve got a re-ownership strategy in place. It allows you to become more aggressive down the road should fundamental factors arise to change the outlook.” This aggressiveness can be channeled into cash sales and additional re-ownership strategies.
What about beans?
The same strategies apply to beans as for corn, but the window for making soybean sales is much shorter.
“The world already has the third-highest soybean stocks in history,” Blohm says. The possibility of a large South American crop looms high and will exert pressure on market prices. Brazil has planted 5% more soybeans.
“Corn still has a seasonal pattern,” Hart says, “but six months after U.S. beans are harvested, world competition flattens the market.”
The upside for soybeans hinges on the real potential for a widespread low pod count in key soybean-producing states. Export demand is another wild card.
No matter what marketing plan and tool set you choose, spread the risk by selling in 20% increments. Be ready to adjust your plan, depending upon global weather and macroeconomics.
“Farmers are risk optimists when they plant a crop, but they tend to be more risk-averse marketers,” Hart says. “I always ask, ‘What’s your risk worry?’ If you’re worried about declining grain quality in storage, move the crop and re-own it. Use a call to establish a floor. Sell cash and buy a call. This strategy has definite advantages, because you’re not necessarily establishing a ceiling and you know your minimum price. There are all kinds of contracts. What’s your risk worry? There’s a contract for it.
“You don’t have to learn new tricks,” he adds. “Your market plan depends on your perspective and where you think the market will go. Then, use a tool to take advantage of that and protect against the downside risk. There’s not one size that fits all. Storing your crops in the bin without a plan is a high-risk strategy. Anything you do beyond that reduces risk.”
Looking forward to the 2014 crop, scout opportunities for pricing corn in the $5+ range or the $12.50 range for soybeans.
Total crop acreage for 2014 is headed higher. “Prevented-planted acreage is unlikely to be as large,” says Darrel Good, University of Illinois ag economist. “That could boost crop acreage by 6.5 to 7 million acres. Contracts on 3.3 million CRP acres expired at the end of September. About 1.7 million acres were enrolled in a new sign-up, so a net of about 1.6 million acres is available for pasture or crops in 2014.”
Some analysts expect a shift from corn to beans in 2014. Good isn’t so sure.
“If you look at nearby prices for the current crop, soybeans are relatively high compared to corn, and that should attract more beans,” he says. “Planting decisions should be based on new-crop prices. The current ratio of November 2014 soybean futures to December 2014 corn futures is only about 2.4. This lower new-crop price ratio may reflect an assumption that corn acres will be cut. If it doesn’t happen, trend yields, combined with a mature market, would build corn supplies, causing lower prices.”
The outlook for next year’s crop size, demand strength, and prices is a work in progress. Weather is a wild card. Game changers in 2013 included a stunning flash drought, historic flooding in Colorado, a cattle-killing October blizzard, and devastating autumn tornadoes. What’s in store for 2014? After four years of subtrend line corn yields, the spectre of a changing climate pattern is attracting new credence.
Hadden isn’t sure, but he’s confident of the short term. “There’s 24 months to sell a crop,” he says. “Twelve months before harvest and 12 months after. I can’t get tied up in emotions. I have to set it aside and focus on what I need to do.”