Don’t Be Lulled into Thinking Prices Can’t Go Any Lower

February 7, 2014 09:00 AM

Commodity prices are above average just two years out of 10, data suggests, below that the other eight, and often dip below average breakeven costs. "Some are under the illusion that prices can’t drop below the cost of production," says Mark Gold, president, Top Third Ag Marketing. They couldn’t be more wrong, he says.
One common mistake he sees producers make: "The view that it’s too late. I don’t want to sell now at $4. It can’t go any lower." However, 30 years of data suggest that $2.40 is actually the risk for corn in 2014, he says. He believes it’s worth spending 30 cents for a $4.40 put option to protect against the potential of a $1.50 price drop. For new crop soybeans, he suggests protecting against the downside with an $11/bu. November put for 50 cents, despite the rich premium. For wheat, Gold advises a $5.70 July put for 30 cents. In Gold’s view, it doesn’t make sense to spend $600 acre to grow the crop but not 30 to 50 cents per bushel to protect it with an option.
"There is still plenty of room on the downside," Gold told producers at the Top Producer Seminar in Chicago January 30. One reason why is that farmers are sitting on 5 billion to 6 billion bushels of unpriced corn and the market fully understands this. Another is that the funds have bailed out of short corn positions.
What makes Gold particularly concerned: given what farmers were able to produce in 2012 and 2013 despite adverse conditions, prices potentially could hit $2.90 or lower if growing conditions in 2014 are actually good. "Can you produce a 15 billion to 16 billion bushel corn crop? I believe you can," he says.
Both $4 corn in 1973 and $8 corn in 2012 told farmers worldwide to "plant more corn at the same time high prices were curtailing demand." So farmers were planting more of what they world wanted less of, Gold says. "Prices go back under the cost of production every time this happens," he says.
Another mistake he sees producers make is to assume that crop insurance will protect income in a falling market. "Revenue insurance will protect the income for bushels of lost production, but not protect the risk for crops you actually produce."
"I don’t want you to speculate with your crops," he says, adding that farmers on average beat Chicago speculators only 7% of the time. But many take that risk, which is why on average, farmers sell their grain in the bottom third of the market, Gold says.
It’s important to combine crop insurance and a marketing plan, he says. For example, through the use of crop insurance, producers can market protected bushels one to two years in advance to capture attractive prices, he says.
One old crop strategy Gold suggests is to sell deferred forward contracts on 100% of stored corn so producers can capture the carry in the market, then re-own it with call options so they can capture any upside. "You can buy a July $4.50 call for 17 cents."
In addition, don’t assume the 30 cent carry in the market will continue, he says. "Carry can go out of the market." Because of that, he advises against leaving unpriced grain sitting in storage.
One strategy some employ that Gold cautions against is selling call options to reduce the cost of puts. "Why open yourself up to margin calls?" he asks. "I don’t want you to sell calls to pay for puts." Conversely, he likes buying call options to offer upside protection after crops are sold in the cash market, without any margin calls.
On market fundamentals, Gold believes the bears see a combination of risk factors moving forward that could hurt commodity prices: growing surpluses, higher interest rates, a strong dollar and the slowdown in China’s economy. Conversely, the bulls believe the market can go higher on strong Chinese demand, higher feed usage and concern over weather issues around the world.

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