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Be prepared for rebalancing

As the end of the second quarter of 2022 approached, equities (the stock market) took a major turn to the downside. Soon after, commodity prices fell apart. December corn fell from a high of near 7.49¼ (June 17) to 5.61¾ (July 22).

Still, the western Corn Belt remained dry. While the temperature outlook changed to cooler for the Midwest, the crop was not off to a great start, with crop ratings on a steady decline. Corn futures were not alone. Many commodities lost value, as traders were exiting in mass. Why did commodity prices drop so hard?

One theory is that, when managed money (large, capitalized funds) invest, they may do so with a formula to own various assets, such as equity instruments like stocks and bonds, as well as commodities. The rules that govern the investment objectives could indicate that the fund maintain a certain percentage of each. If the ratio deviates from the investment objectives, then a rebalancing needs to take place.

As an example, if a fund is designed to contain 60% stocks, 30% bonds, and 10% commodities, and then this balance becomes distorted, a rebalance may occur. It would not be unusual to expect rebalancing to occur at the end of each calendar quarter. If the prices of stocks and bonds fall and commodities are not dropping, then commodities would be overweighted in the fund. The most likely path to balancing is to reduce the holdings of commodities.

Over the last six weeks, stock prices have tumbled and moved into new low prices for the year, with the Dow Jones Industrial Average losing nearly 17%. In general, commodity prices have held up during this time, recently seeing a significant drawdown the last two weeks, suggesting that rebalancing is underway as we approach the end of the quarter.

The takeaway for you as a producer is to recognize that commodity prices are high from a historical perspective. If you’re not sold enough into harvest, you may want to get more aggressive.

World supplies of grains and oilseeds are tight. Therefore, it may be tempting to hold inventory, especially since that plan worked last year.

There are variables that are different this year, such as expectations for more South American production, a worldwide recession that may reduce demand, and expectations for better crop-producing weather. Bottom line, plan for the unexpected. The bullish argument for grains and oilseeds is alive and well. Still, do you want to risk a lot on this potential?

Consider shifting risk, using put options to establish a flooring mechanism against crops you intend to store. If selling crops, consider reinvesting some dollars into quantified risk positions such as call options or bull call spreads.

Regardless of the direction you take, talk to a professional. Make sure you understand the risks and rewards before entering into any position. Go a step further, and calculate how your strategy will work in an up-market and a down-market. That knowledge will provide insight into your ending price, and much-needed peace of mind.

Editor's Note: If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.

Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.

About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.

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