Know your grain marketing contract, analyst says

Understand the ramifications and what-ifs of a grain contract, analyst says.

The recovery in grain prices since August due to robust demand, smaller crops, and weather uncertainty in South America has left the corn and soybean markets vulnerable to explosive upside potential.

At the same time, prices could significantly turn lower, as world supplies are expected to rise in the year ahead.

Since the drought of 2012, row crop commodity prices have generally languished in more of a sideways to lower pattern, spending much of their time at or below the cost of production. The marketing choices farmers have through many elevators has increased over the years. To be more competitive, many elevators have developed what we will term, exotic contracts.

The potential problem of exotic contracts is that some (if not many) of these contracts have provisions that may require delivery of additional bushels or have knock-out levels where you might find you have less bushels sold than you thought. A double-up of deliverable bushels may sound attractive when prices are low, and could become a real headache if prices move higher.

As an example, if you agree to deliver 5,000 bushels at a set price and, in turn, also agreed to deliver another 5,000 bushels if prices are, say, another 20¢ higher, this may sound good when initially entered. However, if prices spike, it could be that you have doubled up on your requirement to deliver at a price that could be substantially lower than where the market is now trading. Or, it could be that you believe you will need to deliver twice as many bushels, and if prices do not hold their rally, you may not have those extra bushels sold.

In 2008, a common contract was the accumulator. Prices rallied to $8 on December futures and many producers were frustrated, as they believed they had double-sold bushels at much lower prices. They would have liked to sell more at a higher level and could not because they might not have production to meet their contracts. In the end, however, December corn futures plunged, dropping all the way, at one point, to under $3. The double-up did not occur. This created even a greater level of frustration, as farmers who thought they had double-sold bushels did not. Now they were dealing with unpriced inventory at prices deep into the lower half of the yearly trading range.

The point we are trying to make is this: As you enter a contract, understand the ramifications and what-if scenarios. Good market advisers take the time to scenario plan and prepare for all contingencies.

In a year like this, when prices could make substantial advances or declines in the next six months, understand how your cash contracts are designed and the potential ramifications based on price moves.

One thought that comes to mind is knock-out prices in certain cash contracts. You enter a contract, and when prices decline below a certain level, it “knocks you out.” You are no longer contracted the full amount of the original contract. This is potentially a very conceivable scenario. When using cash contracts, look to the option market to help supplement or complement your position. The key is to make sure that you are balanced so that, as volatility kicks in and prices move sharply in a directional manner, you are prepared.

Additionally, have critical conversations with your buyer. How many bushels can an elevator execute in hedge-to-arrive or other type contracts that require the elevator to meet margin? What if corn prices were to repeat 2008 or 2012 and rally to $8 dollars? What if there is a drought and prices rally substantially beyond this level?

Beyond communicating with the elevator, connect with your market adviser and lender. Have open dialogue about your cash contracts and what they can do to provide the technical resources and support to shift risk and take advantage of opportunities. Embrace the volatility as a positive, which is providing opportunity that has not been seen for nearly a decade.

Good communication, using the right marketing tools at the right time, and the discipline to revisit and adjust your strategy will be paramount in the months ahead to prepare for what could be a wild ride in grain and oilseed prices.

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If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-TOP-FARM, extension 300.

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.

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