Roy Smith: Managing basis
This is the time of year when markets are historically very active. The seeds for the upcoming crop are just being planted, so there is a world of production risk still ahead.
This year, the production risk is starting sooner than normal because of the areas where there is too much moisture and other areas where it is too dry. Last year’s crop production is six months or more in the past and the trade is still trying to figure out if supplies will last until harvest.
These factors put more than the usual amount of interest in what direction prices might go this summer. There are a lot of factors other than just the flat price that can be watched to get a clue as to what happens in the coming months. My specialty, for many years, has been to watch the long term charts to see how prices act in a normal year, during the same time period. Once the calendar gets past May 10, odds favor prices dropping as production risk diminishes. This year can hardly be considered a normal year.
One of the things I watch, for clues on price direction, is basis. Basis follows a somewhat predictable pattern from one season to the next. I say “somewhat predictable” because the difference between the cash price and futures price reflects interest rates, storage costs, futures volatility and other factors. Grain merchandisers adjust their cash bids to take into account the probability of large basis swings that would affect their profitability.
Basis sometimes makes unusual moves. I noticed one of those instances this week. I run a copy of the bid sheet from my closest elevator every day. In general, the basis for both corn and soybeans is negative and gets wider as the futures price goes up. Again, this reflects basis risk in handling high-priced grain. This has been a frustrating condition for farmers trying to use the futures market for risk management.
Recently, there has been a major change in the local basis. The cash bid for soybeans the last day of April was 50 cents under July futures. Yesterday, the basis was 25 cents under July futures. A basis of 25 under nearby futures is the tightest in many years. It is even more unusual considering that it is happening four months before the beginning of the 2011 harvest. There is a lot of time before more soybeans are available from the current year’s harvest. It is going to take some interesting events for the trade to make a dwindling supply of soybeans stretch to fill the demand.
My take on this unusual situation is that there are very few soybeans still in farmers’ hands and that the processors will pay whatever is necessary to buy those few soybeans. The bid for new crop soybeans is still a dollar a bushel under November futures, so the buyers at this point are not as concerned about the future as they are the present.