Technically Speaking: Storage Fiasco

November 20, 2018 05:55 AM
 
There are two basic decisions involved in marketing a crop. One involves action taken prior to harvest. The other decision is what to do with unsold/unhedged grains after harvest.

I have been an advocate of on-farm storage ever since the Farmer Owned Reserve (FOR) came out in the 1980’s. I paid for a machine shed (flat storage) and a 50,000 bu grain bin back then in two years’ worth of government storage payments aided also by a 10% tax credit in addition to depreciation write-off. They became a cash cow thereafter to aid in capturing the carry. The FOR is history but those grain bins will outlive another generation and be available in capturing the carry which profits should be listed as Other Income on a cash flow sheet or as a “profit enhancement”. Early on I was disgusted by the drying, shrink and storage costs charged by commercial firms and that hasn’t changed today nor has my view on on-farm storage being an essential part of profitability.

Commercial storage was like paying for someone else’s grain bin back then and continues today, only today storage is earned from the market via the carry in futures and if possible, a basis gain over time. While FOR is gone, it may very well have to come back if my scenario regarding a “tariff cold-war” is half right.

There are two basic decisions involved in marketing a crop.One involves action taken prior to harvest. The other decision is what to do with unsold/unhedged grains after harvest. The first may include cash contracting, the use of futures/options, HTA, or a pure form of cash forward contracts or a combination thereof for those with good flexibility. For readers of this column you should be well aware of my focus on the negative effects of tariff talk last spring and my focus to not only consider extensive cash forward contracts, especially for soybeans, as well as significant hedging of same through whatever form you chose. I prefer futures as the hedging tool due to flexibility but will readily admit it requires working capital as an investment to do so. The use of a budget line-item reflecting money for marketing should not be viewed as an expense as so many financial institutions seem to believe. Flexibility in management (knowledge) and marketing (price outlook) is an investment that can help navigate troubled waters.

A HTA is a hedge-to-arrive contract which is usually provided by the buyer of the physical commodity and is the same as using futures as a tool except with certain restrictions like the number of times a commodity may be “traded”. The HTA usually eliminates margin requirements which in limited working capital situations can be seen as a benefit and the recent popularity reflects surging interest in that product. Our studies at Gulke Group show in most cases the producer pays “a service charge” whose costs often exceed those associated costs of futures commissions and interest on the margin requirements. HTA’s are not free but users justify them by requiring less working capital that may or may not justify giving up beneficial interest as the producer is often locked-in to delivering to the buyer eventually. The real benefit is seen by the provider of the HTA product as he will be more assured of getting possession of the physical commodity. If the deal works, all are happy but there are inherent costs as there is no free lunch.

The second decision in marketing a crop is of deciding what to do with excess production not previously forward sold. An intelligent market outlook prior to planting is required for any price outlook. The popular focus last spring was under-pinned by hope that global demand for soybeans would continue unabated. That conventional wisdom and price outlook was in question but was undermined further by the tariffs. As a marketing year progresses, the hedged producer has the decision of what to do with the physical commodity after taking off the hedge when the harvesting process is completed. The decision to do nothing but store and wait may look like no decision but is indeed a decision by itself; no decision is a decision. On-farm storage has its benefits as mentioned above. It is the decision that involves paying commercial storage that plagues those with insufficient on-farm provisions.

 

The decision to store commercially those hedged bushels or merely dump the cash grain and not look back are not easily made. I recently experienced that fate. It involves comparing cost to store commercially versus futures market carry plus any expected basis gain along with an outlook for prices.

In my experience this year the minimum cost to store soybeans to February 1 was 24 cents while the February 1 cash bid was only a dime higher. The bid to March 1 was another 6 cents while a month’s storage was seen as 3 cents making paying 27 cents to lose 16 cents a moot point. Call options to re-own on paper versus paying commercial storage still is a viable option should I feel the opportunity exists for price appreciation under with a near 1.0 bil-bu carryover. I elected last month to store commercially less than 10% of hedged soybeans, a minimum amount just to feel the pain of commercial storage.

Today’s debacle in price as we go into the Thanksgiving Holiday shortened week is an example of why paying for commercial storage would have been something currently not in that thankful category. In spite of hope for a deal later this month, the market seems to be more attuned to the huge carryout for soybeans for this and perhaps next year and not embracing that any significantly good outcome will come from negotiations ahead of an early harvest in Brazil.

Storing corn didn’t look much better last week when a decision had to be made to pay minimum storage or sell the excess for cash. With minimum storage to Feb 1 of roughly 24 cents the cash bid on Feb 1 of 6 cents higher and to Mar 1 of 8 cents higher than cash bids made for a rather easy decision similar to soybeans. Paying 27 cents to lose 13 cents didn’t make economic sense.

A Mar $3.70 corn call option costs 14 cents on Friday, and was already in-the-money 5 cents making actual costs about 9 cents and the decision to dump the 90% of excess of previously hedged corn a no-brainer, while holding 10% in commercial storage just to feel the pain. No decision has yet been made to re-own those corn bushels.

In both cases a March call provided a better investment than the known cost to store commercially. If the prospect for a “tariff deal” turns out to be a sham by the end of the month, chasing good money after bad by paying storage will look more like a losing proposition and end up being a big mistake. The extent of any “good” deal and the benefits thereof of a long term situation makes even beneficial short term gain suspect unless China agrees to buy significant soybeans and maybe DDG’s or ethanol which in all likelihood would take months to facilitate and may take until late spring to mid-summer to achieve?

Arriving at a basis outlook (futures minus cash quotes) continues to be a mystery and smacks of passing off risk to the producer and any attempt to guess what actually will happen is just that, a guess. If I am going to take that risk, there are other ways to manage that risk than pay for someone else’s grain bin.

Making a bad decision is part of the process of learning from mistakes and the key is to make small mistakes, not big ones. I felt paying to store a commodity (soybeans) that had already risen half the value I thought it had potential to do so IF there was a tariff deal (plus the tariff payoff of $1.65 to compensate for a bad policy decision) smacked of a bad deal to me. I bid 2018 soybean crop farewell leaving a token amount in commercial storage for tracking purposes.

Some years ago the Ag community asked to get government off our backs and let us compete in a free-market atmosphere. Believing that non-governmental action would last forever, given the historical evidence that food has been used as a political tool for decades starting with Nixon embargoing soybeans from Japan which started the expansion in Brazil to President Carter, to shunning Russia in the cold war efforts to our current situation of taking the brunt thus far from another political process to reinvent the playing field, was perhaps naïve to say the least; it was only a matter of time before relying on a large buyer to use the majority of our exportable soybeans would turn ugly. The corrective action if a deal is made looks to merely get us back to where we were less than a year ago.

The yet unsigned deal with Mexico and Canada (the new NAFTA) is a case in point. If we are to take signals from the marketplace, the start to this week it speaking volumes regarding soybeans and the odds of Ag gaining appreciably from any deal and is sending a market signal that price will make it very unattractive to plant beans. If China “hints” at buying soybeans for even their reserve, Brazil will feel the pain, but a little too late to affect their planting decisions with the result rather obvious. Just an average crop in S America will be advantageous to China giving them even more leverage. Could it be that China wins in the long run?

What to do with on-farm stored grain is a whole different discussion for another time but basically involves acting like a mini-commercial facility and understanding leveraging physical possession. Given that everyone is looking only at the fundamental situation in corn that is friendly price appreciation, gives me pause as the majority has the tendency to be wrong. Technical action in corn is nearly as disturbing as in soybeans.

For discussion on these topics or others or if you wish to take advantage of my discounted offer that ends November 27th phone 480-285-4745 or 707-365-0601 or contact info@gulkegroup.com.

Time will run out quickly.

Jerry Gulke

JulySoybeans-GulkeGroup

MonthlySoybeans-GulkeGroup

JulyCorn-GulkeGroup

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