Outlook: Work Hedges to Your Advantage

February 5, 2016 05:00 AM

Global consumer concerns of economic growth are exploiting fears about a slide into recession. Subsequently, U.S. equity and several commodity markets experienced a jaw-dropping correction at the start of 2016.  

Outside elements have also forced the energy market into a downward cycle, leading to potential bankruptcy problems for many energy producers. Does anyone remember when the hog market experienced a full-fledged crash and sows were selling for less than $10 a head and farmers were killing feeder pigs rather than feeding them out? This is what the oil complex will experience in 2016.

While consumers are temporarily saving on energy, most are not seeing gains in disposable income. Wages continue to be flat, healthcare costs are increasing and general sentiment is the economy is not heading in the right direction. All of these factors are impacting the presidential election, but there will be limited activity in Washington until elections are over. It will be difficult for agriculture to plan any policy changes to stimulate demand until we are well into 2017 and perhaps 2018.

What can turn the market in favor of farmers? Some big assumptions have to be made. As if the general economy was not bad enough, we know farmers are reluctant to move grain at current prices even though they need cash flow to pay the bills. 

There are rumors farmers are taking in grain and putting it in basis contracts. Essentially they are giving up the inventory but retaining some ownership risk because the flat price has not been locked up on the basis. In years where stocks are tight this can be a good play; but this year it is more of a Hail Mary. 

Those producers are betting on a potential weather scare. Instead of using a paper position in Chicago with a margin risk, they are using a cash position where no money has to be initially exchanged. The problem with this strategy is the end user doesn’t have to work as hard to get inventory from the farmer. While it is emotionally difficult to use futures or options, it forces us to ask ourselves, “Do I really want to keep putting money into this position?” Sometimes a margin call is really a producer’s best friend.

Many believe corn and soybean acres will be up this year. Acres previously abandoned due to weather concerns should come back into production. With revenue down and costs down only slightly, farmers will need all the bushels they can produce to keep their operation afloat. 

My plan of attack: First, if anyone has corn or soybean hedges, don’t liquidate them! Second, make catch-up sales based on seasonal best time (June or July) or a solid retest of the past fall’s highs. 

Third, take advantage of spread changes in existing short hedges to improve the bottom line. It is time to roll all hedges out to capture carry, specifically July 2017 for corn and soybeans. This summer back roll them to the September contract for corn and November contract for soybeans. From now to the summer high, park hedges in the commodity contract month that will go up the slowest if a weather event occurs. 

Remain calm if a 2012-type spring or summer weather event develops. Consider out-of-the-money September corn and November soybean calls. Hold onto hedge positions but be poised to move into a multiple-year short position if drought emerges June to August. If a weather scare occurs, prices will move sharply higher briefly before turning south. 

Meanwhile, if the global economy continues to slide toward recession, the necessity of multiple-year sales will be even more important. It is time to get your head in the game! 

Any opinions expressed herein are subject to change without notice. There is a significant risk of loss in trading futures and options, and trading might not be suitable for all investors. Those acting on this information are responsible for their actions. 

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Spell Check

Western, NE
2/5/2016 09:03 AM

  Bob, I guess you've made more money than you know what to do with. Did you not read what you wrote? Farmers are getting strapped for cash! Otherwise, why would you hear the rumors of basis contracts? In the final analysis, you may be in the right with a long position of some sort, but how much operating cash, interest, line of credit room and banker trust are you willing to burn through until the market turns back in your favor? That's the problem. To mitigate those issues, you have to have so many positions on the board that all you get done is monitoring the markets while they're open. And to turn over the dollars that you need, you may be in and out of positions daily to capture the necessary movement. Just how risky is that Bob? Seems to me the only one that makes the money is the broker/trading platform, clearing house and the exchange. I'd be more than willing to risk YOUR money speculating in the markets. By the way, even as the farmer is sitting on his grain, the end user isn't working hard to get the commodity they need--hell, they're canceling loads to repurchase at a cheaper price!!

nisswa, MN
2/5/2016 11:52 AM

  Eric, Politics and weather move the markets.Wars drove up prices then over production brought in the soil banks coupled with storage payments ,then the crp and more recently the revenue protection plans.The ag business has been operating in over production mode for years.Only the cheapest producers will survive The NFO organization is proof of the failure to disrupt or curtail the agricultural supply chain.

Calvin Hobbs
Garden,City, KS
2/5/2016 10:22 PM

  Eric hit the nail on the head.The low grain prices are the farmers fault.OVERPRODUCTION = low prices. www.afairmarketprice.com check it out and leave a comment.


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