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Focus on Fundamentals

October 28, 2010
By: Rhonda Brooks, Farm Journal Seeds & Production Editor
 
 

F10396 ChipLeon

Pro Farmer editor and Ultimate Farm Quest marketing expert Chip Flory (left) and Michigan farmer Leon Knirk analyzed each aspect of Knirk’s farm to develop the right market strategy for his farm operation.

F10396 Chip

Understanding the relationship between cash and futures prices is critical to picking the right tools and developing an overall market strategy.

Successful marketing is a little like calling the offensive plays in a football game: Some plays fit a particular situation better than others, and no single play works well every time.

The same is true for sound marketing strategies, according to Chip Flory, Pro Farmer newsletter editor and Ultimate Farm Quest marketing expert.

“The biggest misstep that most farmers make is using the same marketing tool every time they sell,” Flory says. “You can’t do the same thing over and over and expect to improve.”

Leon Knirk says that was his No. 1 challenge to overcome.

“I was doing OK with marketing, but I knew I needed to improve,” says Knirk, a diversified grain and livestock farmer from Quincy, Mich., and a Farm Journal Ultimate Farm Quest program participant.

The Ultimate Farm Quest program is designed to help farmers reach a higher level of success—with marketing as one of its cornerstones. Flory is Knirk’s adviser.

At the start of the program last spring, Flory asked Knirk to take inventory of each revenue-generating enterprise on his farm—his 2,000-acre grain operation and his family’s 500-head feedlot. The result is Knirk now knows how much money he invests in each enterprise and the amount of income that each generates.

Based on that information, Flory helped Knirk establish two marketing goals, both of which have already impacted the family’s third-generation farm operation.

First, Flory asked Knirk to develop a better understanding of basis and basis trends for his area. Second, Knirk set a goal to maximize total revenue per acre for the farm.

“That seems like an obvious goal, but some long-standing and relatively conservative marketing plans don’t maximize revenue,” Flory says.

Flory says Knirk historically relied on a scale-up marketing strategy when selling grain to keep financial risks in balance as prices moved higher. Using that strategy meant Knirk also made multiple, relatively small-scale sales at different prices as prices rose.

Flory recommended that Knirk try a different approach that he believes will be more effective for 2011.

“A strategy to maximize revenue per acre means maintaining a higher level of downside price risk by making fewer but larger sales,” Flory explains.

At Flory’s recommendation, Knirk plans to make one sale, most likely a 15% sale, after prices have rallied 30¢.

However, Flory acknowledges, “there’s no guarantee that we’ll get that 30¢ rally, so we’ve also drawn a line in the sand on the downside to make sure the late-summer rally doesn’t get away from us without our making another sale.”

Flory says he realizes the strategy to consolidate what would have been three relatively small sales during a rally into one sale near the top of the expected rally adds to the short-term risk profile and requires a Plan B of selling if the rally doesn’t develop.

“For younger farmers who typically carry a higher level of debt, this strategy to maximize revenue can pay big dividends,” Flory says. “With a Plan B in place, the risk is being managed.”

Flory says farmers can develop these optional marketing plans only if they understand basis and basis trends.

“When you understand the relationship between cash and futures prices, you can do a better job of selecting the sales tools that will provide optimum returns,” Flory says. “Without that
basis knowledge, it’s nearly impossible to pick the right tools.”

Fortunately, Flory says, Knirk had a good understanding of basis coming into the program. “What Leon has gained is confidence that he can select the best marketing tool for a specific situation and time,” he says.

Since Knirk set his two goals last spring, he continues to evaluate each aspect of his enterprise. This analysis led to more decisions, such as downsizing his cattle operation.

“Because of the potential revenue in grain, I plan to sell more of my corn crop instead of feeding it,” he says.

He also decided to focus his grain production on corn and soybeans and forgo planting wheat for 2011.

“That was a tough decision because I like growing wheat,” he says. “But with the basis in my area, it would be better to focus on corn and soybeans.”


F10396 chart

To understand which market tool to use, try this interactive grain marketing aid at http://www.webixi.com/grainguide.

Basis and Futures Define Best Tools

In deciding which sales tool to use, consider whether you expect the futures price to rise or fall and basis to improve or worsen, says Carl German, a grain marketing specialist at the University of Delaware. Some tools allow you to lock in one or both determiners of the cash price.

German uses a four-section interactive grid (right) to show the interrelationships between these factors and the marketing tools that fit each pair of outlooks. For example, if you believe the futures price will rise and basis will improve, you might consider a no-price-established contract (if you have to deliver right away) or call spread or keep a long cash position by doing nothing. If you think the futures price may drop and want to protect the downside while you wait for basis to improve, you would choose a hedged-to-arrive contract (which locks in futures level but not the basis), buy a put option, sell futures or use an options window or put spread.

If you believe that basis is going to weaken, you have a different set of tools: If you expect futures to improve, consider a basis contract or a minimum-price contract. You can also sell on the cash market and buy a call option or a futures contract to reown the grain. If you believe both basis and futures values will worsen, it makes sense to simply sell the grain now and sign a forward cash contract or a season-average contract. Other alternatives include signing a basis contract and buying a put option or selling a futures contract or call option.

—Written by Linda Smith

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FEATURED IN: Farm Journal - November 2010
RELATED TOPICS: Ultimate Farm Quest

 
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