What is a producer to do?
Jul 31, 2008
This week the big news has been the statement by the Sec. Of Agriculture that the opening up of the conservation reserve would not be forth coming. He found the power of the environmental groups was more powerful than the needs of the American consumer. The market is starting to realize the need to bid for acres will be very aggressive next year. The concern about rising fertilizer prices is also getting a lot of play. I’ve been hearing about 250 plus per ton increases in much of the fertilizer used to produce corn. This plus increasing cash rents to all elements in the production process has producers scratching their head and asking.
What’s it going to cost me? How much do I need in prices to make a fair profit for the dollars invested? Finally, is all the cash flow worth the risk with so much uncertainty floating around about ethanol, government policy on CRP and the general health of the domestic and foreign economy?
I would suggest it’s not too big of a leap of logic to argue that corn acres are going to have a difficult time growing next year unless beans price crash or input cost drop significantly.
So the issue now is whether corn is really costing producers say $5 a bushel F.O.B. the farm, what’s fair profit? Currently the Dec 09 is trading at $6.50 which suggests about a 23% return over all cost. I would suggest most business in the United States would just about kill for such a profit margin.
The problem with most producers is they don’t know if they can keep their cost at $5. They don’t know what their yield will be even with some measure of crop insurance. Finally, even if they could keep cost below $5 and be assured that yields were rather stable due to using irrigation, the potential cash flow risk exposure of a hedge position is frightening for many.
So what’s a producer to do in this climate? First off you have to accept no decision is a decision. If you elect to put your money into the crop and have no plan to sell it until it’s harvested and stored in the bin, you are 100% at the mercy of the market. Granted there have been years over the last three where this strategy did pay off but remember, that’s the past not the future. Eventually, supply is going to increase or demand is going to decline and price equilibrium could move dangerous close to or below the cost of production. This is the history of our industry and I don’t believe we have done anything to change this behavior.
So I believe producers have a decision to make. It’s a decision about the form of how you sell. Essentially, it’s our position here at UMS that producers do not have the cash flow or the emotional temperament to handle a net short futures positions for any length of time or level of financial commitment. With the growing uncertainty of the markets and influence of the funds traders I strongly urge clients have to have a limit on their cash flow exposure. By this I mean one develops a strategy that has a limit on risk exposure at the start of the program. Granted, one can selectively hedge the market for a specific level of risk. Get out when it’s been achieved. The problem with selective trading is while on paper it can sound smart, the problems are in the details. Over the years I’ve observed when a client gets taken out of a position with a loss, it’s extremely difficult getting them back quickly into the position on technical signals.
So what’s my point? I would suggest any client who will be trying to take advantage of the expected price bounce in 2009 corn between Jan and April to buy acres must be selling in a “put format”. This implies either you buy calls now on expected fall lows and use the position to insulate a 2009 corn futures position or you wait until spring and buy a put.
The decision comes down to do you buy a call now and speculate the market going to rally to sell or do you wait to sell and put the put but the premium will be expense. Currently, we strongly encourage end users, feed buyers and producers who want to buy calls long term to insulate future selling decisions to be getting ready to start scale down buying of long strategy between August 8 and August 20th.
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