Outlook: Carry is Back in the Game

02:26AM Apr 26, 2014
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Spring has sprung and farmers are wrapped up with the hectic pace of planting. Don’t get so distracted with planting activity, though, that you miss marketing opportunities.
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This time of year, the market is focused on supply. Will crops get planted on schedule? Will summer weather help or hinder production? How will prices adjust if we see excess or a reduction in supply? 

The uncertainty has allowed prices to rally, which could encourage a few more planted acres than projected in the March reports. Further, if we assume that the crop will get planted and we will have slightly less than trend-line yields, it is possible adequate stocks of corn will develop in the last half of 2014. 

My initial assumption is carryover will remain at more than 1.6 billion bushels for corn, and it is likely to increase rather than decrease. This means carry will be coming back into the corn complex.

Capturing carry is critical to improving your bottom line when selling expected 2015 inventory. At press time, the corn market has an inverted carrying charge structure. The September 2014 corn contract is premium to the December 2014 contract, and the December 2014 contract is pre-mium to the December 2015 contract. This is not a normal structure for the corn market.

Let’s assume September 2014 corn is sold at an average $5.10 for expected 2015 production. The best strategy would be to hold until close to expiration, then roll to December 2014 and finally to March 2014. I expect this rolling to net at least 15¢ above the rolling costs, bringing it to $5.25. Then roll from March 2015 contract to September 2015 and start the process all over again to end up in the March 2016 contract for another 15¢ gain. The end result is netting above $5.40 basis the March 2016 contract. At press time, the March 2016 contract was at $5.02, and the rolling strategy in this scenario would have resulted in a 38¢ boost in selling price. 

So, can farmers produce the 2015 crop, put it in the bin and beat the average $5.40 USDA projection for the next several years? It makes good business sense to lock up a solid profit and defend against possible weather markets rather than hope for the best.

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If planting is done by mid-May, the spring high will already be in place. A modest sell-off at the end of May is seasonally expected, and a final attempt to drive out the bear will come on June/July pollination concerns before the fall price decline.
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Dump old crop inventory sooner than later. Do not allow July corn to go below $5 before having all old crop inventory moved.

2014 crop. Focus on selling September corn at $5.10 and every 5¢ higher. Set a target to have 75% of production sold by the May supply and demand report. The final 25% of average production should be sold in late June to early July. Roll long puts into short futures or cash positions by early July to reduce time value cost.

2015 crop.
Aggressively sell at least 10% of expected 2015 crop starting at $5.10 and scale-up selling every 5¢ higher. Farmers should have a solid 50% of expected production sold by the time the market reaches $5.25 or by mid-June, whichever comes first. If the risks are understood, it is possible to move to higher levels, but realize the need to roll into put positions when moving from the March 2015 contract to the September 2015 contract in early March of next year.

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I’m convinced an increase in soybean acreage will occur. Tightening of old crop supplies and fulfillment of Chinese purchases has driven up the old crop price, but we are seeing a solid increase in imported soybeans from South America. By late June to early July, the risk will turn decisively negative for new crop beans.

Remain focused on being 100% sold using a long November put. Roll up the puts when the strike price goes up 20¢ for a less than 10¢ premium. 

Some might have sold deep-out-of-the-money old crop puts to reduce the time value cost of owning November puts. I’m reluctant to do this. Instead, I’ll aggressively sell calls once we get closer to July. Focus on at least $1 to $1.50 out-of-the-money November calls to help reduce the cost of the long November put. 

2015 soybeans.
Don’t sell expected 2015 production until 100% of the 2014 crop is sold and we are closer to late July to early August. 

For now, focus more on corn than soybeans. If anyone is motivated to sell expected 2015 production, consider selling November 2015 deep-out-of-the-money calls at a strike price you’re satisfied with. I suggest at least a $13 strike price (trading above 45¢ as I write this outlook).

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The wheat market is on borrowed time. Roll all hedges back to the July 2014 contract in anticipation of carry coming back into the market. Once we get into July with adequate supplies, the carry incentive will give producers motivation to store at least into December.

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This is not a market to be short futures or cash for the remainder of 2014. If bankers require inventory to borrow, buy puts and roll up. Buy October and December puts closer to the money, but sell June and July puts at $110 or less to help offset the time value cost. The next six months will remain strong but as the market adjusts, the deferred contracts will come under pressure.

Many believe the real gain is going to be later than the trade anticipates. Yes, the December contract, significantly discounted to the June contract, looks like a good buy. The August contract is more than likely a distant contract month buy. But, I’m confident excessive high summer hog prices will result in an unexpected drop in prices, just when the public gets excited about being long hogs.

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Meanwhile, the cattle market has been rational and stable during extreme price movement. We are beyond the seasonal high period, but inventory numbers suggest tight supply well into summer. So again, I prefer a put below the market at breakeven rather than being short futures or cash basis the June and August contracts.

My biggest concern is how much to pay for feeders. If I’m correct about declining corn and soybean values, the cost of feeding will be lower in the last half of 2014. With the strong price of nearby fat cattle, the pressure will be on feeders in the fall. 

Push to lock up feeders on any solid correction by midsummer. In August through October, there’s risk of buying high-priced feeders and pricing them in a potential down-trending market in the first half of 2015.

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