Uncertainty Spells Options in 2011

November 17, 2010 06:16 AM

Approaches to market planning are as numerous as the farmers and advisers who use them. We asked the marketing advisers who will be presenting their outlook for 2011 at Marketing Rally in Chicago on Dec. 1 and 2 to rate the current markets from 1 (extremely bearish) to 6 (extremely bullish), tell us what they think might be the next “black swan”—the game-changing factor that blindsides everyone—and share their thoughts on the best marketing strategy for the year ahead. Here’s what they see as 2010 harvest winds down. We hope you’ll find food for thought and ideas you can use in your sales planning.


Advance Trading believes that in this environment, options are the answer. USDA’s bullish October report laid the foundation for market volatility for all crops over the next nine to 12 months. Upside potential is high, but there also is considerable downside price risk. Buying a put option sets a floor for inventory in storage or expected production but also leaves the upside open. If basis is favorable, you might make cash sales and buy calls.


The major issues and potential black swans to monitor in 2011 include: Acreage. U.S. corn producers need to plant about 3 million more acres in 2011; any less will result in higher prices. Yield. The U.S. has not had a catastrophic crop disaster since 1995. Even our genetically modified crops are not immune to extreme natural disasters. Ethanol. If the blenders’ credit is not reauthorized, we’ll likely see speculative deleveraging. Fund regulation. Any move by Washington to curtail the funds’ massive positions in grains or to broaden enforcement of the position limit rules would result in deleveraging and at least temporary deflation of prices. Use options strategies to protect against a price decrease.


The key issue over the next year will be the impact of the declining value of the U.S. dollar. It will be positive initially because it makes our commodities cheap and leads to higher exports. Long-term, foreign countries eventually will stop buying our debt. This, in turn, will lead to a lack of growth in China, lower demand for commodities and lower energy prices. Where will that lead corn and soybean prices?


The biggest issue for crop producers in 2011 is complacency. Prices are back to 2007–08 levels and it’s easy to think they will remain high throughout the acreage war of 2011 and anyone can make money.

There are plenty of downside risks, ranging from ethanol demand being torpedoed to a 1930s-style trade war developing via currency manipulation or old-fashioned trade barriers. A rapid exodus of spec-fund money could occur without any change in the underlying crop fundamentals. The cause could be regulatory or because the stock market or real estate suddenly looks attractive.

Managing margins is critical, maximizing the spread between total production costs and the sales prices received. A plunge in market prices without a corresponding drop in inputs can ruin a promising year.

A standard markup selling strategy will keep you out of trouble but potentially leave $500,000 on the table. Producers need advisers who have international contacts and insight into the behavior of investment funds and money flows.


The corn price–driving race to ethanol occurred on the heels of crude oil exceeding $150 per barrel, causing politicians to look for answers to ease gas prices. This is a temporary solution for the next 10 years or so. Battery-powered cars are going on sale and eventually we will see a massive swing toward these vehicles as more auto companies introduce their own models. The thought of never having to buy gasoline again will be irresistible. We currently use about a third of our corn crop for ethanol. We will be challenged to find new demand to fill the coming void. It may very well be filled by export demand from countries in the Far East. Their desire for a better lifestyle will be a silver lining for the American farmer.


Farmers face a tough crop mix decision. With corn’s beginning stocks for the 2011marketing year estimated at less than 1 billion bushels, there just isn’t any supply-side cushion, so corn should do what it can to increase acres. But depending on conditions in South America, beans shouldn’t be willing to give up acres. With input costs for corn on the rise and $10-plus bean futures for 2011, buying those additional acres for corn won’t be easy.

However, we can’t be as bullish at $5 as we were at $4.50. There will be price setbacks between now and the March Prospective Plantings report, but there will also be some excellent selling opportunities along the way. The trick will be to remain patient and let the rally run…but then have the guts to pull the trigger on some aggressive 2011 crop sales for corn and soybeans.


As producers try to do a better job of marketing, there always seems to be some surprise that throws a wrench into the marketing plan. It’s hard to forget the Carter grain embargo, Chernobyl, mad cow or Oprah’s hamburger comments. Here are a few potential black swans: A trade issue. Recently, the Japanese claimed the Chinese had illegally tried to claim Japanese territory. There is also the current rift between the Chinese and the U.S. about chicken imports. What if they stopped buying grain from us? U.S. energy policy. Will blenders’ credits be extended? U.S. elections. We could see big ag policy changes. World weather. Short-term, there’s the La Niña question. What is next?

There is no way any of us can know the future, but buying options can put you in position today to take advantage of whatever lies ahead tomorrow.


The current dilemma is how to market grain into a rationing market. Aggressive summer producer selling based on USDA crop ratings of 70%-plus in the Good and Excellent categories left some farmers oversold on 2010 crop. Now, after the pivotal October report, they are faced with increased volatility and disappearing carrying charges.

The effects of rationing will be amplified by potentially explosive and unpredictable basis gyrations until we know enough to find a top in our corn market—which may not occur until around the March 31 Grain Stocks or Acreage reports.

Meanwhile, grain buyers may pull away from forward buying just when farmers want to sell. It happened in 2008 and few will have an appetite to buy $5 to $6 corn knowing they could have a margin call for $2 or more if the crop is bad in a major producing country. The inverse between July and December 2011 could be huge; note that in 1996 we did not get $5 futures for December 1996 when July went to $5.25.

This volatile marketing environment requires understanding futures and basis plus a well-financed producer who can withstand the daily trauma of a market that is just too dynamic for many participants.


Next year will be a very exciting and dangerous time for farmers. Billions of dollars continue to pour into commodities as an “inflation hedge” and a larger portion of those allocations is moving into the agricultural sector. As of this writing, combined long positions held by index and hedge funds are at record levels. This buying, combined with the historic drought in Russia and disappointing corn crop in the U.S., is providing the base for a very volatile market for grains and oilseeds.

Although global supplies remain adequate for wheat and soybeans, the extremely tight supplies of global corn stocks will force corn to “take” acres from competing crops, keeping our markets very volatile as we head into spring.

Both producers and consumers of grain need to become much better risk managers as we go forward. With tight credit and erratic markets, it will be paramount for successful producers to develop a marketing plan that encompasses crop insurance, cash sales and the use of futures and options. This will require both farmers and bankers to understand how crop insurance and market tools work together.


The major issue is that there are not enough acres. The corn market is walking a tightrope, especially if Argentina’s crop goes downhill because of La Niña; China reports a crop of 150 to 155 million metric tons and needs to buy more, leading our exports to be underestimated by 200 million bushels in the October report; or our yields fall another 2 to 3 bu. per acre. We need 4 million more acres of corn and with 3 million going to soft red winter wheat, where will they come from?

The corn-to-wheat price spread is $1.45 now; if it gets to $1, it will add to corn feed use. The cattle herd is already down and the government threw a $5 billion check to the hog industry, trying to keep it in business. Corn at $6.50 would ration feed.

With one in five U.S. children living below the poverty line and one in four receiving food stamps, it is not impossible to think the U.S. government might decide that the 4.7 billion bushels of corn used in ethanol should be available for food. Should that happen, either EPA could use its authority to tweak the blending percentage or Congress could let the blending credit expire at the end of the year. That’s what I see as a potential black swan.


Next year will likely be as much or more volatile as 2010. Following a huge injection of speculative
dollars, grain markets continue to move along paths that are not for the faint of heart.

Producers must respond to volatility with flexibility in every step of their 2011 grain marketing. As cash sales are made, call strategies may allow growers both the opportunity to participate in higher prices after sales are made and the peace of mind to make them.

In this price environment, it is important to capitalize on good prices, not focus on outlook. If
you cannot make a sale or are uncomfortable making sales, consider a put option strategy to protect the opportunities that are being offered. Take no bets about where prices will go when corn is near $5 and soybeans near $11. These are rare opportunities, even with today’s turbulent conditions.


We know from experience that it’s important to be prepared for anything. In the end, it’s uncertainty that makes marketers uncomfortable. So make it your ambition to manage uncertainty.

The first step to that end is to shift your thinking from relying on other people’s predictions to relying on your own preparedness. The next step is to actually prepare for every possible scenario: “What will I do if USDA delivers a shocker and the market moves up fast, or down fast?” Have triggers in place and the discipline to act when those triggers are hit. It sounds simple, yet farmers struggle with this because they want certainty and they have come to believe that gathering more information leads to more certainty. Actually, the opposite is true. More information simply delays and frustrates decision making.

A case in point is all the hype about the 300 million bushels of corn that USDA made disappear, reappear and then disappear again. One minute the market is said to be “bearish unless something shocking happens,” then something shocking happens and everyone is caught off guard. If you do scenario planning in advance and prepare for a shocking event, you aren’t one of those left scrambling when the “shocking” report comes out.


Major issues for 2011 include acreage mix, weather, taxes and exports. The first three are self-explanatory. Exports are strong because of the depreciating value of the dollar. However, not just our administration but governments everywhere are pursuing the same approach. This currency war makes currency valuation a possible black swan as the world works out of slow growth. Should the dollar appreciate, our exports would suffer. Other possible black swans include unknown events such as a terrorist attack and government policy changes.

Old forecasting methods don’t seem to work any more, so pay more attention to yields off the combine, not what you project earlier. For risk management, work closely with your marketing adviser.

Corn is high enough for now, but we are long-term friendly toward prices due to the strong global demand base and tight supplies. Soybeans could rally because later-harvested U.S. bean yields seem to be off the high levels of the early-harvested acres, and La Niña typically brings adverse conditions to the Southern Hemisphere. Wheat is neutral, following corn. Cotton outlook is slightly negative because global acreage should increase, especially in Brazil, where dry planting weather in Mato Grosso caused some shift to cotton.

Checklist For Sales Planning
> Determine sales target prices
> Consider possible scenarios
> Separate basis and futures decisions
> Select appropriate sales tools
> Plan for cash-flow needs
> Arrange for market financing
> Revisit plan and revise as needed

MarketingRally no yearWant to hear more from these analysts? All will be on hand
at the 2010 Marketing Rally, Dec. 1 to 2 at Pheasant Run Resort in St. Charles, Ill. Click here for registration information.


Top Producer, Mid-November 2010

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