Outlook: The Real Action Is Just About to Start

04:45AM Mar 26, 2011
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As is typical every planting season, farmers are worrying about how fast they get their crops in the ground and how good the stands are. As spring turns into summer, they will worry about how much heat and rain their crops get. Long-range forecasts indicate the current weather pattern is not losing strength fast enough and the risk is increasing that some type of yield reduction event could occur this year. With the concern about lack of demand rationing, anything other than above-trend-line yields could entice the market to keep a significant weather premium in place until yield is more certain and some demand rationing has occurred.

Even with all of the current uncertainty, producers should plan for an average crop and defend against the exception. This is a wise course of action this year and down the road as well. High profits will motivate the corn acres to get planted. A significant amount of fall tillage will put producers in a prime situation to get the crop in on schedule, and end users will be motivated to ration usage until the new crop comes on board. The only concerns are how quickly the bull trend will reverse and how violent the transition will be.

As we know, the recent violent correction off the March supply and demand report has spooked many of the bulls because of concern in regard to demand.

I believe the fundamentals that have pushed the market up so hard are still in play. Because of building demand prospects with China and India and our own domestic ethanol corn production needs, producers need to re-examine their selling methods for the next two marketing seasons. I know that most producers focus on selling cash inventory because they don’t want to deal with the "evil" futures or "costly" options. However, I must remind everyone that the producer who sold $4 to $5 corn and $8 to $10 soybeans lost a lot of opportunity now that corn is well above $7 and soybeans are above $14. Simple cash sales can be a very expensive way to sell inventory if one is not careful.

Until demand and supply are realigned, producers need to be very careful in giving up control of their inventory. Setting floors is an excellent approach, but producers should have a game plan for participating in upside potential. As I see it, the big questions now are:

  1. What should you do with unpriced old-crop inventory?
  2. When and how should you sell new-crop inventory to capture profit but avoid excess cash-flow exposure?
  3. When should you consider multiple-year sales?
  4. What can you do about inputs?

In the coming months, I plan to offer answers to all of these questions in this column, on the "U.S. Farm Report" TV show and on my Outlook Today blog.

Sales index key

Excellent sales opportunity ..... 10
Excellent buying opportunity .... 1


Sales index: 8

Producers need to separate their opinions about the corn market into old crop and new crop. I expect old-crop corn to be extremely reactive to any changes in supply. The chances are better than average that lead-month futures will need to move above the 2008 numbers to ration usage during June and July. At the same time, I expect, the new crop will be reacting to major increases in planted acres, making it difficult to move above $6.25 unless trend-line yields drop below 162 bu. per acre.

Three strategy options. Handling old crop and new crop differently requires two separate strategies. Producers have a choice to make: The market has reached a near-term price plateau basis the lead month futures right below $7.50. The recent retreat in prices has producers who are holding inventory in a little distress.

The first alternative is to take the price, clean the bin and start on expected 2011 sales. I know that anyone who is holding old-crop inventory wants the March highs back, but right now that will not happen unless Mother Nature gets nasty.

A second alternative is to go for the final price event associated with a summer weather event. If producers are right, they will be well rewarded. In case they are wrong, the risk should be prices close to the $6 level.

A third alternative is a compromise position: sell inventory now and re-own it in a limited risk call option strategy in the July contract to enable participation in a summer event if it occurs. The best choice depends on each producer’s ability to handle risk—remember, hogs get slaughtered!

When dealing with new crop, the sales index is at 8 because we are experiencing profit for 2011 corn that is not common prior to spring planting. The only reason it is not at 10 is the potential explosion in the market if any type of yield reduction event occurs.

Here are my suggestions for handling the corn market:

  • Give serious consideration to having more than 100% of an average production priced in the December 2011 corn crop contract between $6.05 and $6.30.
  • I assume that most producers bought some basic crop insurance for expected production for the 2011 growing season.
  • Give serious consideration to buying some form of upside price protection if December corn starts making new highs in April. I suggest a known-risk, vertical-call strategy.
  • Where possible, focus on selling September corn rather than December to deliver against—this will allow you to take advantage of spread premiums and early harvest positive basis bids.
  • Once we move into July, consider liquidating call protection when risk of a yield reduction event is over.

In regard to 2012 sales, it is time to be alert and ready to act if there is a summer weather event, but don’t move too soon. I suggest a selling price no lower than $5.50 to $6.25 to sell December 2012 up to 75% of expected inventory in futures rather than forward cash contracts. A selling plan must be flexible when you are considering this form of a sale in a market that is experiencing significant demand growth.

To add to the 2012 selling plan, move the contract forward and backward to optimize the spreads. This is why futures contracts are recommended over cash sales. It will be necessary to have some form of call protection in place this fall for the spring of 2012. One must assume that a seasonal rally (just like this year) will develop from the fall lows to the spring highs. Finally, those in futures will be open the basis. I would not act on 2012 basis sales unless an exceptional event is going to occur and basis narrows to historically tight levels. If that is the case, lock up the basis and remaining short futures.


Sales index: 7

Strong interest in vegetable oil from China is helping to keep the soybean oil market firm. There is some concern that this has caused crush margins to weaken due to a larger supply of soybean meal that has to work harder to compete with corn dried distillers’ grains. Two additional weights for the market in the near term are the big crop coming out of South America and the earthquake in Japan. The old-crop high is now in place for a while and there is less than a 50/50 chance that new highs can be made, but there is also little reason for the market to significantly drop below the correction that occurred in early March. In my opinion, soybean producers will be caught in a trading range for the next couple of months, but that situation could quickly change.

As we move through USDA’s March 31 acreage projections, the big variable will most likely be whether or not U.S. producers plant more soybean acres than expected. Right now, I see limited excitement. It seems like it is going to be very difficult to get much more than the March 31 increase. If the planted acreage figure is confirmed, the situation will get really interesting.

If demand stays constant and there is a 43.2-bu. trend-line yield, carryover should move up to 156 million bushels next year. I don’t believe this level would be able to sustain new highs, and it would support a bearish tone going into harvest. On the other side of the equation, however, a less than 1.2-bu. drop-off trend line could result in carryover well below 70 million bushels, which would force major price rationing.

Producers have a decision to make: Take the sure profit that is being offered ($13.50 plus soybeans for November 2012) or go for the brass ring and hope there is a summer weather scare event. If you have been reading my columns during the past several years, you know I lean more conservative that many of my counterparts in the trade. I’ve learned that swinging for a home run all the time leads to a lot of strikeouts.

I suggest the following:

  • Focus on selling November 2012 beans between $13.50 and $14.50 basis the November contract.
  • If the market takes out $14 after the March 31 acreage report, invest in some upside price protection in the form of a vertical call strategy in the November contract.
  • Anticipate that you will hold the call all the way into August, which implies that almost all of the premium value associated with time value decay will be lost if the market does not rally due to yield reduction.

In a multiple-year selling strategy, I have to say, limited action should be considered until August.

Soybeans have reached a value where they do not need to go any higher. However, I believe there is a lot of risk associated with summer weather markets. Get a floor under the market, but have a plan to participate in a bull market move after the March acreage report if, thanks to the weather, the market starts to rally due to uncertainty about yield.