Published on: 14:46PM Sep 25, 2008
The doctor’s credo of doing no harm is what we hope Washington does with the financial bail out. We know it smells, but if we don’t get the credit markets working, it’s going to be a much bigger problem. I am concerned about the demand prospects for the next year or so. I anticipate after all the dust settles, bankers in the future will be more cautious in loaning. For example, in the past they would get an appraised value of the property to be bought and loan up to 80% to 95% of the value dependent up the type of loan. On top of this, they would many times give a home equity loan for $10,000 and up simply because they gave the loan. I would anticipate the percentage of the appraised loans to go down say to 60% to 70% and the home equity loans to really dry up. This effectively reduces money supply and liquidity to the economy when it’s needs more growth. If we don’t see economic growth, good loans could suddenly come into difficulty.
The housing market correction is only a part of the much bigger problem which is high energy values! If we don’t as a country move faster in removing our dependency upon foreign oil, the current economic situation has the potential of being the tip of the iceberg. As the country and consumers go more into debt to maintain their standard of living, while energy values continue to rise because of our reliance on oil which is a finite resource, I believe the economic system is increasingly being built on a weak foundation that could eventually crumble.
So my bias right now is at best I assume stable and at worse stagnate demand prospect, a complete opposite pattern that we saw this time last fall. On the supply side of the equation, early yields in the Midwest seem to be coming in better than most expected. I’m starting to lean to the side of the argument that corn and bean yields in the October report have greater odds of increasing than decreasing. Finally, I would suggest a large percent of the unpriced grain is going to be stored and held well into next year. This all suggests to me it’s going to be difficult to rally the market as much as producers want since we saw $8 corn and $16 beans last year.
Suggested strategy: If you are going to store corn into the March to May time period, consider selling a deep-out-of-the-money call at the strike price you would be willing to sell inventory. For example, May corn is now at $5.90, let’s say you want to sell it at $6.60
I would suggest you sell the May $6.60 calls today for 40 cents. This will in effect pays you for all your storage cost to next May and give you some protection to downside risk if your upside expectations are not met. Remember, you are unpriced in the cash inventory and are taking all the downside price risk. Equally, if the market does rally you will have some margin risk on the out of the money calls but the loss will be offset by the increase in your cash sales. I would also note if you do elect to hold unpriced you may want to focus on locking up basis, remember if prices rally you could see basis widen.
In summary: I’m concerned about demand not meeting recent learned expectations of constant growth and supply exceeding our concerns for decline. Subsequently, producers are going to get caught holding inventory for price gains that don’t materialize and make it very difficult to market next years inventory efficiently when production cost are increasing. By selling calls it reduces your upside unlimited potential but pays for your storage cost and gives some downside protection while still maintaining a reasonable upside price gain if you are correct about market seasonal firmness from fall to next spring.
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