Outlook: Rational Buy/Sell Actions

February 7, 2011 10:36 AM

Bob UtterbackBoth the bull and the bear will be holding their breath this spring and summer as we find out what producers are going to plant, if crops are planted on schedule and how the growing season shapes up. If we knew the answers to these supply issues, had inside information on how major export buyers and end users are going to operate, we might have a chance at perfectly trading the markets.

Unfortunately, this type of clarity only exists in the movies. Decisions regarding when to buy feed needs or sell production are often made based on incomplete, emotional, cash flow, and sometimes misleading and/or conflicting information. This means that, more than ever, farmers need to have a set of rules they use to make a decision rather than rely on a hunch or special news alerts.

Follow the money. Someone once told me, "Don’t follow the rhetoric, follow the money." To this aim, I will be watching the following things to help me make a decision on when to recommend selling.

1. Eventually, the rules of supply and demand will prevail. The concern for 2011 is that we could really stretch the rules because we don’t have enough acres to go around and demand must be rationed through price, rather than through increased production. I do know the returns that many producers are starting to post on cotton, corn and soybeans will motivate a long-term increase in acres. While it may not be this year, it is only a matter of time before South Africa, Russia and South America react to high profits.

2. As the market moves toward the top and the public gets bullish, we should see some technical indicators of bear monitoring. This is a case of watching what the smart money is doing, not what they are saying!

Once we get past the March acreage reports, new monthly highs will be a clear signal that some distress is occurring with supply. The implication is clear; If you are short cash or short futures, you need to adjust your upside risk exposure.

The slope or speed of the price advance is important. If we see futures accelerate and have gaps of price action where no trading is occurring, this is typically a sign that panic is setting in for sellers because of margin calls while the bulls are getting confident and increasing their position.

The second indicator would be if the cash market fails to keep pace with the futures. If the difference or basis starts to widen, this indicates that the commercials are becoming less interested in the market. While the speculative interest can push the market short-term, the trend cannot remain strong if it does not have the long-term interest of cash buyers.

3. Another factor will be how to sell expected production. With the emergence of globally strong demand, we have to start being realistic in how aggressive to sell the markets. During this time period, a put option format should serve sellers well because the trend should be bullish, rather than a straight cash sale.

The period to be a big seller is from March to August. Since such big risk exists this year, from now to mid-June producers need to have a put option mentality with limited cash flow risk and the ability to benefit if the market rallies. As we move into June, start opening up the selling position a little as you get comfortable with the crop yields and be net short futures. Being net short with no upside potential from the fall lows to the spring highs could result in giving up significant price improvement. Straight cash sales should be an increasingly expensive way to merchandise grain.

4. The final factor producers need to watch is input cost control. For example, when practical, consider multiple-year cash rent periods rather than one year because I fear the trend is only in one direction … up! As more acres are brought into production on a global basis, the demand for fertilizer will soar. I see only one way to offset some of the risk: Buy corn and soybeans on fall lows every year as close to break-even as possible to offset the risk of a major price advance. Low interest rates from this past fall may not be seen again in our lifetime. Work with your banker to get the longest time period of fixed rates possible.

Now is the time to put your plan together, get your family, partners and/or banker on the same page, and then implement the plan.

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