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Poor Production Year Leads to High Feed Costs

23:01PM Oct 27, 2012

This year started out fantastic on the supply side; but Mother Nature had a different agenda. A sorry production year for many Midwest corn and soybean farmers set the stage for higher feed costs and a difficult year for livestock producers.

Your head is probably spinning like mine right now. At this point, we are hoping for a historical seasonal rally from the fall lows to the spring highs to ensure adequate planted acres. But what is the plan for managing risk if events work against positions?

Corn 12-3-45678910

The market is trying to keep prices high enough to motivate farmers to hold inventory into next year, while rationing future use and stimulating planted acres. Prices above $8.50 have shut down demand until a supply reduction event occurs. With tight stocks, it will be hard for lead month corn futures to trade below $7 for long. Spreads and basis will be active from now until May, with the bulls dominating as end users buy hand-to-mouth.

If adequate acres are planted next spring and we get average weather conditions, I fear many will be trapped into storing until summer. This plan could work, but storing $7.50 to $8 corn has a lot of risk. I suggest dumping all inventory between December and March when prices are between $7.75 and $8.25 cash and re-owning it in a limited risk option strategy equal to the storage cost and risk premium to get to mid-July.

Lock up good returns for 2013. If it’s produced for less than $5 with
average yields, buy crop insurance to insure the base and plan a scale-up sell in spring. Buy in-the-money September puts at a strike price equal to the maximum margin call on a short futures position. Do not sell cash 2013 inventory until 2014.

Beans 12-3-45678910

December to March could be volatile for soybeans if bad weather develops or flat if good prospects develop.

If storage space is limited and cash flow is needed, store beans rather than corn, due to beans’ sell-off since August. However, if South America has a good crop, a price hit in March might force storage until July or August.

If old crop prices bounce between December and January, sell November 2013 contracts between $13.75 and $14.50. For flexibility, buy deep-in-the-money November puts equal to the maximum futures margin call afforded. Then focus on selling deep-out-of-the-money nearby puts to pay for monthly interest and operating costs. Refrain from forward cash sales; if a bullish supply event occurs between now and next fall, the basis level should explode.

Wheat 1234-5-678910

Wheat has the largest stocks going into 2013 globally and can respond quickly to increasing supplies. We know western production regions are dry and drought could continue. Some concern with global wheat producers is keeping prices firm. As corn stocks stay tight, the pressure on old crop wheat should keep prices stable.

Farmers with wheat in the bin should closely watch corn and soybean complexes for a bearish trend. If outside markets turn negative, wheat prices should quickly die. Buy deep-in-the-money July puts, but sell deep-out-of-the-money March 2013 puts
to pay for monthly operational costs. Be priced by early February or March between $8.75 and $9.25.

Livestock 1-2-345678910

Fall liquidation of cattle, hog and chicken inventories gave consumers short-term price relief for now. As we move into 2013, significant reduction of livestock inventories should drive prices higher next summer.

Livestock producers must get feed supplies in place—the actual crop in the bin, if possible. If positions on paper are needed, increase long exposure to cover potential increase in basis risk—at least 1.5 times normal January to August needs. After November, no active hedging is suggested. If required, a long put strategy is preferred to a cash sale or futures.

Sales Index Key

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