Wild Markets

February 26, 2013 08:32 PM

Strategies for volatile times

Don’t become too sanguine about crop prices. "Within 18 months, prices could fall below the cost of production," says Mark Gold, president and CEO, Top Third Ag Marketing. "It’s the market’s job to run inefficient producers out of business."

He’s not the only one concerned. "With 91 million acres and trend yields of 161 bu. per acre, prices at harvest could be $3 to $4 per bushel," says Kevin Van Trump, market analyst. "I’m more bearish than I’ve been the last two to three years. Yields above 143 bu. per acre will give us the biggest crop in history if we harvest 91 million to 92 million acres."

"I don’t believe the market will wait two to three days after a rain so producers can price their crops."

It’s all about Mother Nature. With a corn yield of 145 bu., Van Trump predicts corn will trade in the $5 to $7 range. "Another severe drought and a yield similar to last year, prices could go to $10. If funds come back in, the markets could explode."

Thus far, producers have been sitting largely on the marketing sidelines. "The average producer has done little marketing of 2013 corn and soybeans," says Dave Fogel, vice president, Advance Trading. "I don’t remember a year with less booked."

He thinks that’s a mistake. Many producers are waiting until there is a rain in the Western Corn Belt before making any forward sales, Fogel says. "I don’t believe the market will wait two to three days after a rain so producers can price their crops," Fogel says. "A $1 to $1.50 market drop on new crop corn and we could be flirting with break-even." In his view, it’s a possibility.

Jerry Gulke, president of the Gulke Group, says it’s possible that more corn inventory exists on farms than indicated in USDA’s Jan. 11 stocks report. "If the market embraces similar conclusions, price rallies can evaporate quicker than they materialized," he says. Gulke admits there is no proof yet that this actually is true, but based on recent conversations with producers, it’s a distinct possibility.

"Within 18 months, prices could fall below the cost of production."

In addition, given the huge demand reduction that was necessary due to short corn crop, it would only take an average yield of 125 bu. per acre on 99 million acres planted to get by, Gulke says. "Many are worried about the drought, but the dry areas are getting smaller and moist areas are getting smaller, suggesting that even a 152 bu. per acre yield would be problematic from a price/supply standpoint," he notes. It would be tough to get back the billion bushels of lost demand if producers grow more, not to mention the problem if producers grow 2 billion bushels more, he says.

Even if corn yields are sub-trend in 2013 and come in at 150 to 155 bu. per acre, prices could tumble with corn acres nearing 100 million, Gold says. "I don’t think we will see another drought like last year. If we do, we will run out of grain and could see $8 to $9 per bu. corn and $20 to $21 soybeans. He cautions producers not to count on that. "More likely is that yields in 2013 could be shockingly high," Gold says. If so, corn prices could be on their way to $2.90.

What concerns Gold the most is that corn production could increase substantially at the same time demand has fallen. "You will produce more of what the world wants less of," he states. Corn demand is in the tank. Exports are around 150,000 metric tons per week when they should be 500,000. Feed is the bright spot for the corn market."

Because of the risks facing producers with the potential of price swings, Gold advocates the use of options. "The only way I know how to manage risk is with long options," he says. "You can buy a $5.40 corn put for 30¢ that establishes a $5.10 floor." Producers who think prices are headed to $9 or $10 can buy a call option to protect the upside if they have already made cash sales.

By the first of March, corn could fall to $5 per bushel, he adds, and $3.50 by the end of June. "You can protect against that with puts." However, he says that it’s a mistake to sell calls to cover the cost of puts by selling call options and open producers up to the risk of a margin call if there is a drought.

Look at History. Recent history suggests how much risk the market provides, he says. In 2008, soybean futures reached $16, but within three months crashed to $7.90.

Fogel does not believe in changing marketing strategies radically from year to year. Too often, he says, producers market based on what happened the previous year. A better way, he says, is to write down your marketing plan, then execute it. "The market does not pay you to hold onto your bushels for the 2012 harvest," he adds. Producers can sell grain in the cash market, but re-own it with call options that gives them upside protection should prices take a sharp turn upwards, Fogel says.

For producers who have not used options and are not excited about 30¢ premiums, Fogel suggests getting started with short put or call options. These have a shorter time frame, but may only cost 15¢. The downside to using them is that once the options expire producers have no price protection compared to a traditional long option. Options are not static and must be managed, he says.

Fogel does not favor basis contracts. If the basis is strong, he thinks it far better to sell grain in the cash market to capture strong basis, then protect the potential for stronger futures prices with a call option. "It’s important to have a flexible marketing strategy," Fogel adds. He also is not a big fan of scale-up selling because he has seen too many producers sell too much when prices are low and not enough when prices are high. "Instead of scale-up sales, buy an option and be done with it," he says.

He disagrees with the statement some have made that 95% of options expire worthless. "That’s impossible," Fogel says. That would imply that the trades have no value to either buyers or sellers, which Fogel believes is implausible.

Three steps can help producers determine market direction, in the view of Van Trump: traditional fundamentals and trend analysis; macro factors influencing the market; and following money flows, in particular the behavior of index funds in commodity markets.

Van Trump pays special notice of Brazil and not only its production. For example, while producing more corn, it will be using more of it internally. "Five new ethanol plants in Brazil are corn-based," he says.

Declining Ethanol Demand. In the U.S., he notes that 5 billion bushels of corn were used for ethanol during 2012, but no more than 4.2 to 4.5 billion in 2013. He sees potential good news on corn exports from China. "If corn declines to $4 or $4.50, China will be a huge corn buyer. China is a price buyer of corn and a quantity buyer of soybeans."

Van Trump says soybean acreage of 77 million to 78 million and yields of 42-43 bu. per acre will result in a big carryover. That’s on top of the potential of a very large crop in South America, he adds. Van Trump advises producers to look at new crop prices of $13.30 or better. "Old crop, meanwhile, has rallied because of logistical problems in Brazil," Van Trump says. "Beans aren‘t getting to the ports." He suggests using old crop rallies as an opportunity to price new crop beans. "I would hold onto old crop until late March or April, however, when the U.S. runs out of beans."

On strategy, Van Trump recommends three sales zones: sell 30% to 40% pre-planting, 20% to 30% during the growing season, and 30% to 50% post-harvest.

Van Trump has future price concerns. "Money is flowing into agriculture right now. Investors are seeing the profits you are making. But when interest rates and the stock market go up, short-term investors will pour out of agriculture."

Wild Markets TP p58

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