Roy Smith: Pricing one year ahead
I get a lot of questions about pricing grain in the 'out years', 2011 and 2012.
In general, I have been cool to the idea. For one thing, I have not done it myself, so I cannot speak from experience. Another factor is that there is so much time between now and the time the crop is harvested that economic factors, such as input costs, can change.
That has the potential to make what looks like a good sale into an unprofitable strategy. A third factor that plays into the decision is that crop insurance coverage levels will not be set for several months yet. So, sales must be made with no price protection if there is a production disaster and prices go drastically higher.
My theory is that if an individual is going to forward price a year or more out, the time to do it is when the markets are in a big rally. Prices today certainly fit that requirement. This is especially true where the prices for corn and soybeans are being buoyed by the fundamentals in the wheat market. There are additional warnings that apply to making such sales.
Sales so far in advance need to be done with either futures or hedge-to-arrive contracts because the negative basis will be very wide. That means that the seller will benefit from basis narrowing. It also means that here will be margin calls if futures are used and possibly as well if hedge-to-arrive contracts are used.
Prices for the deferred contracts do not necessarily follow the nearby contracts. In the corn market for example, the 2011 December contract closed Thursday at $4.32, while the nearby December futures closed at $4.14, 17 cents less. In price action since the low on June 29, the nearby contract has gone up 74 cents while the 2011 contract has gone up only 51 cents. There is less upside potential in the deferred months. There is also less risk of the price shooting a lot higher at this point.
The corn contract for 2011 is offering a premium to this year’s crop in corn, but in soybeans there is a discount of 16 cents compared to contracts for delivery this fall. That reflects the current tight situation in the cash soybean market as well as the fact that there is a South American crop that will hit the markets in the spring of 2011 before supplies in this country are available that fall.
I am not opposed to selling a small increment of the 2011 and 2012 crop if such sales fit your management style and marketing plan. Certainly with normal yields and current prices on inputs, $4.34 futures on corn should make most farmers some money. Pitfalls mentioned make the strategy at these price levels not as much of a “no brainer” as some would have your think.
There is a principle that says the market is always most bullish at the top. It is difficult to visualize any factor more bullish than yesterday’s announcement that Russia has suspended exports of wheat. Action today makes one wonder if the top may be close in the grain markets. I am not predicting that prices are about to drop. Markets go both directions. Seldom does the market promise profit for everyone in it. Be cautious at these price levels!