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Market Strategy: Expect Wide Ranges on the Way Up

November 2, 2010
By: Jerry Gulke, Top Producer Market Strategy Columnist
 
 

 

TP 056 T10179

> The bullish scenario is obvious and the MACD Index said "buy," but expect the market to trade with volatility, perhaps within some wide ranges on the way up.

As the market digests USDA’s Oct. 8 reports and tries to discover what price will be needed to ration usage and ensure more acres next year, it helps to look at some of the major factors that got us to where we are, and perhaps get a focus on what could be developing (see numbered boxes in chart):

1. Thanks to the June 30 Grain Stocks and Planted Acreage reports, July trading took out previous February to June highs, suggesting fundamentals have changed.

2. After failed attempts in August, corn broke out above $4.50 resistance in early September as yield concerns caused by the hot summer nights surfaced.

3. During September, corn failed in three attempts to fill the downgap left in October 2008 on reaction to USDA’s report that month, which caught the market long, believing the crop would be less. At that time, the debate regarding global production destruction versus demand destruction began.

4. The Sept. 30 Grain Stocks report set the stage for a limit-up move or upgap on the October report exactly two years later. The 2010 weekly upgap corresponds to the 2008 weekly downgap, leaving a trading island, as if to say that the global economy is taking second place to global production destruction—just the opposite of the global demand destruction seen in 2008.
Note what happened to corn prices after the postharvest breakout above $4.50 in 2007 based on the idea we were running out of oil and needed ethanol (see "A" in the chart).

This time, it isn’t about fuel but food and feed. We can just stop driving, and we did, when gasoline reached $4 per gallon. We can’t stop eating. In a food versus fuel debate, food wins, but at what price? How soon and how high will prices go?

 

Strategy. Record harvest prices times excellent yields on my farm equals record gross income. The carry nearly evaporated, giving me a disincentive to store. There is a potential explosion brewing if all the factors fall into line, but timing is everything. I chose to manage any further upside risk on paper: There will be no grain stored on my farm for the first time. Although I may use the conventional method of re-ownership with calls or call spreads, I will also explore the less conventional method of selling out-of-the-money put options.

Example: I suspect the February average price (crop insurance revenue benchmark) will have to be relatively competitive with soybean prices in order to buy acres from beans. If I can sell a $5 March put at, say, 30¢ (arbitrary guess)—meaning if prices are below $5 futures at option expiration (Feb. 21)—I will re-own the inventory I sold for much higher price. If corn doesn’t drop below $5 by expiration, I keep the 30¢.

Lead-month corn futures should not close below $5 prior to March 1 unless the technical analysis in the chart is flawed or something major changes in the global economic or agricultural outlook. If that should occur, I will be glad I sold my crop(s), and owning corn below $5 may need to be seriously re-evaluated.


Jerry Gulke farms in northern Illinois and North Dakota and has a consulting office at the Chicago Board of Trade. Contact him at jerry@gulkegroup.com or (312) 896-2090.

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FEATURED IN: Top Producer - November 2010
RELATED TOPICS: Marketing, Columns

 
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