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Storage 2009: A Gambler’s Game?

December 4, 2009

For sure, 2009 will be well remembered by most crop producers and handlers. From delayed planting through a slow growing season to the challenging and interminable harvest, farmers seemingly have been thwarted at every step. Now the question becomes how to price binned grain.

This decision rests on three legs, says Jim Kendrick, retired University of Nebraska professor: futures prices, basis and the cost of storage.

Futures Prices. In mid-November, the market offered modest gains to storage. From December to March, corn futures improved 14¢; to May, they rose 25¢ and to July, 34¢. Soy-beans rose 5¢ from November to January, 10¢ to March, 14¢ to May and dropped back to 10¢ for July.

Have you protected those returns or are you gambling on price improvement?

You can project what price you'll get on later sales in three ways: by current futures prices; by applying a seasonal price index developed by George Flaskerud and Demcey Johnson of North Dakota State University to the current futures price; or by applying it to USDA's projected season-average price.

The table below shows the results for Nov. 10. Based on the futures price, there is room for improvement, particularly in May and July.
Basis Improvement. Most years, basis (cash price minus futures price) worsens at harvest, then improves when grain begins flowing out to buyers.

This year, with the prolonged harvest and extended drying period, there's going to be a longer window before basis improves, says J. C. Hoyt of CashGrainBids.com.

However, Bryan Doherty, senior market adviser for Top Farmer Intelligence, believes that "although basis is widening as harvest picks up, it may not widen as much as it would in a typical harvest year.

I would consider locking basis in corn. For soybeans, if basis is stronger than usual, lock it in; otherwise, hold off."

Price Protection. Given that the market is offering a return to storage, you might want to forward contract to lock in both futures and basis.

Hedging by selling futures will lock in the futures price while allowing you to wait for better basis. If prices fall, the hedge account gains value (you buy back cheaper). If they rise, you have to pay margin calls, but in this case the cash grain rises, offsetting the margin.

"Producers should consider locking in some corn production," says Randy Martinson of Progressive Ag Marketing. "July is the time frame that right now has the best opportunity, as it has full or almost full carry. By July, corn basis also should be at its best, as many end users will be looking to meet short-term needs."

Fence It. If you want to wait for a better basis and you don't think futures prices will change a whole lot, you can buy a put option to protect your downside and sell a higher strike-price call to bring in a premium, lowering the cost of the put option purchase. This is known as an options fence.

For example, Bill Biedermann of Allendale described this strategy on Nov. 5: "Buy a $9 March soybean put and sell an $11.40 call for zero cost. This will only make money if the market goes below $9 (yes, we think that) and you can only lose money at expiration if it is above $11.40 (OK, anything can happen…but $11.40?)."

Finally, you could simply store but buy a put option to protect the downside. It costs more than the fence strategy, but leaves the upside open.

Sell Now. If the carry offered won't cover your storage costs, you don't think basis will improve or you are concerned about quality, simply sell and turn your attention to 2010.

"This allows you to collect your money, pay bills and not worry about keeping grain in condition," says Kendrick.

If you don't think basis will improve much but think futures might rise, you can buy a call option. This is the strategy Martinson recommends for soybeans.

This gives you the right, but not the obligation, to own a futures contract at the strike price, Kendrick says. "You risk only the premium you pay to buy the option. If prices do not rise, you are out the premium—unless you sell the option before it expires, in which case you may recapture a portion of it. There are no margin calls if prices fall.

"If you buy futures instead, you don't have the premium cost to make up, but if prices fall instead of rise, you will have to meet margin calls," he says. "And you may wind up with a lower price than if you had simply sold. You basically are speculating on prices through the reownership."

Regarding prices and basis, "The biggest question that has to be answered now is what quality of crop ultimately will be harvested [and stored]?" Martinson says. "If quality is an issue, it is likely that the volatile market action will continue."

By the Numbers  I  Corn seasonal average moves are modest; production surprises lead to volatility

103  May seasonal-high index value (1978–99)
96.5   August seasonal-low index value (1978–99)
21%  Price increase in short-crop years
30%  Price decrease in larger-than-expected crop years

Top Producer, December 2009

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FEATURED IN: Top Producer - DECEMBER 2009
RELATED TOPICS: Corn, Soybeans, Marketing, Crops, USDA

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