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Harnessing volatility

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This was a volatile year for corn and soybean farmers, with corn and soybean prices soaring to new all-time highs. The grain markets went higher, as global demand kept increasing, and we had a drought for three crop years in a row. By that, I mean the drought in the U.S. in the summer and fall of 2011, in South America in 2012, and the extreme drought in the U.S. in 2012.

How you came through this year depended a lot on which area of the Corn Belt you farmed and the risk-management decisions you made.

In the seminars and webinars I've held over the last three months, I have heard lots of stories of extreme winners and losers in the huge price swings that we have lived through in 2012. With tight global stocks of corn and soybeans, odds are good that prices will stay very volatile through the first two quarters of 2013.

For the last several years, I have recommended this three-step risk-management plan:

  • Buy the right RP crop insurance policy for your farm. In 2012, for many of you, this decision was probably the most important decision you made.
  • Get 60% to 100% of the insured bushels hedged ahead. How much you hedged and at what price level also had a huge impact on your bottom line.
  • Buy puts on the bushels that were not covered by crop insurance. The puts ended up being worthless, but it was a lot less painful than paying in margin calls on hedges.

Which group are you in?

Which farmers were successful in using the volatile markets in 2012 to make more money? And which farmers had a tough time turning a profit in 2012 even though prices went to new all-time highs?

The first big difference between the two groups was yield. The farmers in North Dakota who had a crop that was 10% larger than their five-year average had the potential to make more money than the producers in southern Illinois who had 20-bushel-corn and 10-bushel-soybean crops. The farmers in Illinois needed the price protection from their RP crop insurance policy.

The second major difference was in how much the farmers sold ahead. The farmers who were aggressive early on with hedges or forward contracts that were over 50% sold before planting time took the biggest hit. Many farmers who were in the extreme drought area ended up being closer to 100% sold when they saw their crops burn up. The last $3 rally in the corn market and the $5 rally in the soybean market did not do them any good. In fact, if they were oversold, it increased their cost of buying back the oversold bushels.

May 2013 CBOT Soybeans

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May 2013 CBOT Corn

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The farmers who did well but left some money on the table were the producers who made incremental 10% sales as the markets rallied throughout June, July, and August. They had some corn hedged at $8 to pull the average prices up on their earlier $6 hedges. Many of these producers also reduced the number of bushels they were hedging, as they realized their crops were getting smaller.

For soybeans, the $17 hedges pulled up the average on the $14 hedges.

The farmers who bought puts or put spreads and rolled them up ended with some large paper losses in their hedge accounts. At the end of the year, they came out with a very good average selling price. They also didn't have to worry about delivery commitments on bushels that they were not able to produce.

I am not a big fan of put options, but this year, the farmers who lost $1 per bushel buying corn puts and $2 per bushel buying and rolling up soybean puts still came out with a good average price for the corn and soybeans they sold at harvest. This, once again, illustrates how you need to use all of the marketing alternatives that are available.

Looking ahead to 2013

If I expect another volatile year in the grain markets, what did I learn in 2012 that can allow me to do a better job in 2013?

Here are six guidelines that I suggest when you make your cash and new-crop decisions in 2013.

1. Stay disciplined. If you forward-sold part of your crop in 2012, then make sure you also sell some ahead in 2013. It was a good decision in 2012, and it's still the right thing to do in 2013.

2. Learn from your 2012 mistakes. If you were 50% sold in one sale early in the growing season with forward contracts, you will want to change your ways. A series of sales will likely achieve a higher average selling price than making the one big sale.

3. Use the seasonal odds pattern. If you sold in increments in the April-August time period, you didn't hit the high, but you came out with a good average. You were also able to reduce the number of bushels you sold when it became obvious that you had a smaller crop.

4. Use all of the different alternatives. If you stopped hedging and bought puts, you had price protection without having a delivery commitment. The puts were locking in a price well above the February average that the RP policy had guaranteed, and as the market moved higher, you were able to roll the puts up or liquidate the puts when you delivered the crop at harvest.

December 2013 CBOT Corn

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November 2013 CBOT Soybeans

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5. Work on marketing as a team. You can get input from everyone before you pull the trigger, which ends a lot of Monday-morning quarterbacking. Once you have made the team decision, the next question should be where you sell some more.

6. Ask yourself what-if questions. How will you feel if the corn market moves up $2 or down $2 after you make the sale? Or if soybeans move up $3 or down $3 after you make the sale? Your answer to these questions may make you change the amount you sell or how you sell it. Better to think it through now than to worry about it later.

Defining success

Don't feel bad about your hedging in 2012 when the prices were higher at harvest than where you had sold ahead.

Keep in mind that the December 2012 corn contract had a $4.60 trading range from the $3.89 low to the $8.49 high, and the November 2012 soybean futures had a huge $9.29 trading range from the $8.60 low to the $17.89 high.

If your farm had an operating profit this year, it was a good year. Or if you were in the extreme drought area, the crop insurance check will keep you farming in 2013.

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