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Drought sets up 2013 prices

My phone rang continually when the grain markets turned sharply higher in early July. The terrible drought dropped 2012 yield and profit prospects for many farmers across the Corn Belt this summer. It was a volatile and emotional time for many producers as they watched yield and profit potential go down and grain futures go up. That's why it is so important to have a well thought-out risk-management plan.

December 2012 Corn vs. December 2013 Corn

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Here is the three-step risk-management plan I've suggested the last four years.

1. Buy the RP crop insurance policy that makes the most sense for your farm. For many farmers, the decision to buy a revenue crop insurance policy in 2012 will keep them farming in 2013.

2. Get some of the insured bushels hedged ahead. A lot of your new crop hedges may be below the market, but as long as you did not forward-sell more than your crop insurance guarantee, you'll be able to settle up on the grain contracts yet this fall.

3. Buy new crop 2012 puts. This year the puts are likely to be worthless at harvest, and you do not have a delivery commitment on those bushels.

Take a long-term view

In this volatile environment, it is very important to take a long-term view. You need to look beyond this year's drought and make plans for 2013. It is important to realize that as the drought intensified in the summer of 2012, price and profit prospects improved for the crops you will grow in 2013.

Here are four key questions to consider when making 2012 and 2013 crop sales.

1. What are the final sizes of the 2012 corn, soybean, and wheat crops? The USDA overestimated the crop yield potential this spring, so could it be too conservative on the final crop harvest this fall?

2. How much demand destruction will occur? So far, the USDA in recent reports has projected these cutbacks in demand.

For corn next year:

• 650 million bushels less feed.

• 300 million bushels less in exports.

• 100 million bushels less for ethanol.

For soybeans next year:

• 115 million bushels less in exports.

• 35 million bushels less in crush.

3. How much will South America be able to ramp up corn and soybean production in 2013? The early indications are for a 5% to 8% increase in soybean acreage next year and 1% to 2% more corn. If normal weather develops in the southern hemisphere, the world will turn to South American supplies by the end of the first quarter of 2013.

4. What are the acreage and yield prospects for the U.S. in 2013? Crop acres jumped by over 9 million acres from 2011 to 2012 and could jump by another 2 to 4 million acres in 2013. Imagine what prices will do by the harvest of 2013 if we have 98 million acres of corn and a trend line yield next year.

November 2012 Soybeans vs. November 2013 Soybeans

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2012 Crop strategies

Here are my suggestions for selling the 2012 corn and soybean crops.

For 2012 cash corn. The current alignment of the corn futures shows that storing will not pay for the 2012 crop corn. Plan to be sold out of cash corn by early January 2013. If you want to retain ownership, do it with call options or call spreads. If you're an end user, be buying as you need the product.

For 2012 cash soybeans. The large discount of the 2013 soybean futures to the November 2012 contract is telling you to get the cash soybeans sold off the combine and any stored soybeans sold by Thanksgiving. If you want to retain ownership, it is less risky to hold call options or call spreads than to hold cash soybeans in the bin.

2013 Crop strategies

For 2013, you have a lot more variables to plug in and to consider. At this time, I'm not comfortable giving specific recommendations, but I suggest that you use the following five guidelines.

1. Make sure you have your 2013 inputs locked in as soon as possible. I made the recommendation to buy fall 2012 fuel, dryer gas, and all of the 2013 fertilizer in late June 2012. With December 2013 corn futures rallying over $1 per bushel this summer, odds are good there will be at least 98 million acres of corn planted in 2013. This large acreage increase and more corn in South America will increase fertilizer demand and costs.

2. Lock in cash rent and, if possible, try to get a flexible rent contract.

3. You have a lot more risk in holding 2012 inventory than selling 2013 ahead. So don't get real aggressive selling 2013 ahead until the 2012 crop is sold.

4. Consider getting 10% to 20% of your 2013 corn crop hedged ahead if December 2013 corn futures rally up to $6.80 to $7. Get the bushels you cannot get protected with RP crop insurance in March 2013 sold ahead before the pricing is set for the 2013 crop.

5. Consider getting 10% to 20% of your 2013 soybean crop hedged ahead if November 2013 soybean futures rally up to $13.50 to $14. As with corn, plan to get the bushels you cannot get protected with RP crop insurance sold ahead.

Final thoughts

Rationing is a painful process, and with corn above $7 and soybeans above $16, it may take a long time to buy back demand. The higher that prices go now, the lower they are likely to go later.

One of the frustrating developments from this rally is the unrealistic rent expectations landlords have for next year. Be careful.

History has shown over the last 30 years that small crops have “a long tail.” That means, after prices peak on the supply-scare rally, they will fall further and keep falling longer than you can imagine right now.

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