The Chicago Board of Trade began as a place for farmers, elevators, grain millers and speculators to trade grain for future delivery.
The industry standardized the contracts calling for a specific quantity of a specific grade of a commodity to be delivered in a certain month.
These exchange-traded contracts are called futures. These futures contracts gave farmers the ability to sell their crop ahead (hedge with short futures), allowing secured financing to grow the crop and to lock in a known price.
Food companies and flour mills could buy wheat or corn (hedge with long futures) ahead for a year in advance and know the costs of the grain they'd be buying. This allowed them to build their budgets with a known cost.
The speculators were there to try and trade and to make a profit. They also kept the market liquid so that when a farmer wanted to sell or a mill wanted to buy, they would step in and make the market.
Since 2002, an increasing part of the trade has been from index funds. These funds view commodities as an asset class, and they accumulate them by buying and holding to benefit from higher commodity prices. From the fourth quarter of 2007 through the first quarter of 2008, these funds poured billions of dollars into the commodity markets.
In early March, most of the large grain companies stopped buying grain from farmers for more than 60 days. This caused a near panic for some farmers who all of a sudden wanted to be able to hedge. It is confusing to me that now when many farmers cannot sell, they suddenly want to sell.
I believe that the grain companies pulling out of new crop pricing is a temporary pause until the markets pull back and the credit markets stabilize on Wall Street.
All of the grain companies review or renew credit lines monthly. This is a time of great uncertainty in the credit markets, and the major grain companies are all solvent. But they do have hundreds of millions of dollars tied up in margin calls, as grain prices have moved to record highs.
Odds are good that once the credit markets stabilize, the grain companies will be able to secure new credit lines, and then they will be back buying new crop grain.
Until then, you have a lot of different risk-management alternatives to consider.
- If you are sitting on old crop corn and soybean inventories, you are taking futures and basis risk. You can certainly reduce price risk and take a lot of money to the bank by cashing in grain from the bin.
- You had the opportunity to buy a revenue insurance product like CRC, RA, or GRIP. Using this insurance, you could get income protection on 70% to 80% of your crop. I know these policies are expensive, but it locks in a very high floor price on your 2008 crops. It also gives you a lot of marketing flexibility.
- Many elevators will allow you to buy a put option and then deduct the cost of that put when you deliver your grain. Buying put options is expensive if you do it yourself through your commodity broker or you have your elevator buy them. This is a year when buying puts needs to be a part of your marketing plan.