Year in and year out, the odds favor those who price in the spring or, perhaps, late June or early July on weather scares. USDA's game-changing January reports make it even more likely that the bears will dominate prices this year. But your best plan may be to develop strategies to put into effect no matter what happens.
If you have nothing sold, at this time there isn't much to be done other than wait for a spring or summer rally, says Bob Utterback of Utterback Marketing. "However, be realistic; I don't think we'll see more than a 50% retracement unless planting is delayed,” he says.
Likewise, Richard Brock of Brock Associates believes the markets will show a spring or early summer rally, but it will be from lower levels. "The market has peaked, and it's time to lower your sights to a more realistic objective,” he says. "Any time that new-crop soybeans are over $9 and corn is over $3.75 cash is an opportunity to price. I would not gamble more than 40% unpriced.”
Farmers, however, insist that corn bulls may still have some life: Corn still in the field and under snow could be left unharvested, corn in bins could be rejected if infected with mold, and light test weights mean livestock operations and ethanol plants will need more bushels to get the same energy output.
It's harder than ever to guess where prices will go, notes Mike Hogan, manager of Stewart-Peterson's Market360 service. In general, a standard deviation (SD) above the average price is the top value range and one SD below is the bottom of the value range, he says. "However, we have seen three or four SDs above the average; that gave us $8 corn,” Hogan says. "Then the market sold off and retreated well below the value range in an effort to return to the mean price.”
Hogan suggests that rather than guess where the market is headed and base your pricing strategy on that outlook, you accept that volatility is part of today's marketing battle and use scenario planning to identify an action plan for each scenario.
"Marketing isn't about ‘I think' the market will do this or that; it is about being in a position to take advantage of wherever it goes,” agrees Mark Gold of Top Third Ag Marketing. "Put options are always a good strategy. I don't feel producers should enter marginable positions [such as hedges] in the volatile markets we see today. It is better to recognize option premiums as part of your budget,” he says.
Spending 30¢ for a $3.60 December put where downside risk exists to $1.90 is a good risk-return ratio, Gold says. "Your expenditure protects three or four times that much and allows you to keep the potential to sell for three or four times that much if a rally occurs,” he adds.
The key to optimizing the price you receive is to separate the world (futures) price from your local basis, says Jim Kendrick, University of Nebraska professor emeritus. "The production uncertainty that leads to strong prices early in the season also often leads to poor basis bids,” he says. "Waiting to lock in basis closer to delivery time sometimes adds 8¢ to 10¢ per bushel.”
Kendrick suggests assessing each strategy for its world price effects and its basis effects.
For example, if you think futures prices and basis will worsen between now and when you wish to deliver, you can lock in a flat cash price via a forward contract or lock in the basis and a floor using a minimum price contract. In essence, your elevator buys a put option for you.
Alternatively, if you think futures may drop but basis will improve, you'll want to use strategies that keep the basis open, such as hedged-to-arrive contracts or exchange-traded futures/options. "In this case, the decision rests on whether you want to be locked into delivering to a specific buyer or keep that option open by buying a put option or entering a futures hedge, which requires cash-flow availability,” Kendrick says.
Those who already have attractive sales on the books or who want to gamble that a significant weather event will take futures higher have choices, as well. A basis contract or minimum price contract will lock in basis if you like the basis your buyer is offering.
Doing nothing or buying a put for downside protection just in case you are wrong will keep your basis as well as your world price component open, Kendrick says.
What if USDA "loses” some of the huge 2009 crops? Or what if a weather event does set in? You could buy a call option against previous sales, Kendrick says. "As futures prices rise, the value of the call rises,” he adds.
Your decision to defend previous sales in case of a summer rally should be deliberate, Utterback says. If there is such an event, use it to catch up on sales. "We are down near technical support,” he says. "You may want to take profits out of hedges and move to a conservative vertical put, buying a $3.90 put and selling a $3.10 put to keep the premium to a minimum.”
An option fence is another choice that works if you want put option protection and you think prices will rise, but not very far, Kendrick says. It is similar to an elevator's min-max contract. "You buy the put option, then you sell a call option at a higher strike price, which brings in a premium,” Kendrick says. "You are providing the buyer with the right to own futures at the strike price. If prices do not exceed the strike price, you are ahead by the amount of the premium. If prices do rally above the strike price, the buyer can exercise the call and you must sell futures at that level—in effect, entering a hedge.”
That means you should use caution regarding the amount of production you cover this way if you've priced or hedged some.
Top Producer, March 2010
- MARCH 2010