Farmers around the world have experienced a fantastic production year. There is more wheat, corn and soybeans than a year ago. Even with solid demand, we are experiencing a global building of stocks.
With ample supplies, the market will start to develop carry. This implies the deferred contract price will be premium to the nearby contracts, which is one of the ways the market gives producers incentive to store forward. The difference between the cash market and the futures market [basis] will get wider, again encouraging farmers to store the product until supply is tighter than demand.
The problem: Producers are basing their pricing decision on the flat price, not carry and basis. They are unwilling to sell inventory since the price is low and, in many cases, below the cost of production. The end result is they will store production and, in addition to all the storage cost and risk, sell it at a lower price than when they put it in the bin.
If it is good enough to store, then it is good enough to sell. If the net selling price is depressive, there is always the option of (speculatively) trying to capture upside flat price potential once the bin doors shut this fall. Be very cautious! I prefer to keep all long positions in nearby in-the-money calls and not buying anymore carry and time value than possible. Target purchases in October after the supply and demand report or when the last 20% of the corn or soybean crops are being harvested.
Since producers are storing a lot of unpriced grain with the hope of a big flat price rally, little to no attention will be placed on selling anticipated 2015 inventory. Looking forward to June and July of 2015, if we see fewer corn acres and more soybean acres, conditions are set for a market that will be extremely sensitive to weather. Unfortunately, if we were to experience another year with corn yields above 170 bu. and soybean yields above 46 bu., prices could slip even further below the cost of production in the second half of 2015.
To help pull the selling trigger, producers need to decide now how to manage their risk. Buy deep-out-of-the-money September or December 2015 calls on lows this fall at price levels where cash sales can be insulated from a weather market event. Focus on buying the lowest strike price possible with no more than 15¢ for corn and 50¢ for soybeans.
In summary, grain farmers must be prepared for a period of margin compression that could last longer than many think is possible. I don’t expect much downside price pressure in land prices or related production costs until we are well into the 2016 marketing season. This all suggests the earlier producers sell, the better; but, be flexible to defend due to a change in fundamentals, such as a major bullish weather event or a change in government policy.
While grain prices are breaking, it’s been the opposite for meats. We have experienced all-time highs for pork and beef prices in 2014. The continued slow expansion of poultry, beef and hogs has kept supplies extremely tight.
Looking forward, the big question is what to do. This fall, first focus on protecting feed costs for next spring and summer feed needs.
From the latter half of 2015 to early 2016, pork supplies will be at risk unless we see unexpected event(s) such as a return of PEDv. If problems arise this winter, aggressively start pricing for the eventual expansions starting to show up in the pork and poultry sectors.
While cattle herds are not going to expand as quickly, some growth will occur with lower feed costs. If you raise feeders, lock up long-term exposure on any bounce this winter close to the old highs. From here on, keep a floor under the feeder and fat cattle prices to sell into old highs.