Market Commentary for 9/8/17
Corn market volatility has been reduced this past year. This year's low (so far) is nearly 30 cents higher than last year's low while this year's high was about 30 cents lower than last year. This kind of trend can be typical of abundant supply. Another sign of abundant supply is that spreads between futures contract months are wide, encouraging the market to store and hold grain.
Tuesday will be another USDA report. Bulls are expecting a crop size reduction. Bears doubt any production decreases because of the reasonably good August weather. The market could swing 10-20 cents either way after the report. With the trade expecting an average yield of 167-168 from the USDA report, anything higher could cause the corn board to test lows from last week and last year.
Storing Old Crop Corn Going Into Harvest
Like many farmers, I still have old crop corn stored on my farm (33% of my production). Unlike most farmers in this situation though my stored corn is completely hedged with a short (sold) futures positions. Basis near my farm never rallied to the usual levels of the last 10 years. As harvest is approaching, I need to either move corn before harvest or continue to hold. Following are the questions that should be asked when making this decision.
What Is The Market Carry?
Currently the spread from Sep '17 to Sep '18 is about 45 cents (where Sep ’17 is 45 cents lower than Sep ’18). This is the equivalent of making 12.5% return on investment ($.45 spread / $3.50 futures value). With an operating loan from the bank at 5%, it is more profitable for me to work with my bank and set up terms where I continue to sit on my grain and capture this carry instead of moving my grain and paying down the loan.
How Do You Capture That Market Carry and Get the Bank to Go Along With It?
The first and most important step is that I have to already have the grain sold/priced using futures. This allows me to show the bank that I have reduced risk and have a plan in place. Since I was already short Sep futures in my hedge account from my 2016 production, I had to get out of those futures by 8/30/17. Therefore, on 8/28/17 I bought back those Sep ‘17 futures and immediately sold Dec ‘17 futures at a 14.75 cent premium. Thus I have collected some of the market premium.
Why Dec ‘17 futures and not Sep ‘18?
I haven't decided when I will actually set basis and move this old crop corn. I may need to move some before the end of the year, or late winter, maybe even next summer. If I hold until late summer of 2018 I could get 45 cents of market carry. Selecting Dec ‘17 futures helps me keep my options wide open.
Is There Basis Risk?
The basis price near my farm today is similar to levels I could lock into later in the marketing year. To minimize risk, I could lock the basis in today and take the guaranteed market carry later. However, basis is the lowest I've seen in 10 years. It could go down further, but I don't expect that to happen with the information I have today. I think basis will be the same today or hopefully better down the road.
Do You Have Enough Available Storage?
I anticipated this possibility last spring; therefore, I put up additional storage. Additionally, yields on our farm having been averaging 1.5% increases for the past several years, so I was going to need extra storage eventually anyway. In the meantime, if the market is going to pay me to store grain, I might as profit from it.
My Final 2016 Corn Positions
With a plan for my remaining basis levels secured I can calculate my final 2016 corn prices. Every year I analyze how well I did in futures, basis and market carry. Each of these marketing categories move independent of each other, so I want to identify each area of success and missed opportunity. I can then use this information to make better decisions in the future. Following details my final cash value by marketing category.
My first 2016 trade was placed in March of 2013 on about 5% of my production for $5.61. Following are other trades I placed against Dec ’16 futures:
- 10% in 2014 for $4.30 avg.
- 10% in summer 2015 for $4.40 avg.
- 35% in Apr-Jul 2016 for $4.03 avg.
- 20% in Oct-Dec 2016 for $3.42 avg.
- 20% in summer 2017 for $3.77 avg.
Combined and weighted, these values averaged $3.91 (brown in the chart below), which is better than any futures price available in the last year.
BUT....I also picked up additional premium by selling calls and working other option strategies during a sideways market. Those trades all totaled together increased my average sales values by 27 cents on my entire production. I applied this premium to my average futures value to arrive at an average futures sale price of $4.18 (red line on chart below)
Like most farmers, in hindsight I should have sold more corn last summer at $4.40. However, I'm still please with these results. I didn't hit any home runs throughout this, but I hit plenty of singles for a win.
As mentioned above, 2016 corn basis was the lowest in 10 years. Consistent abundant supply kept pressure on prices.
In early spring of 2017 I set my basis for summer delivery. At the time I was concerned a summer weather factor would create a strong futures rally, forcing basis to plummet and long lines at ethanol plants (like in previous years). None of this happened though.
In hindsight I should have waited until the very end of August and delivered corn right before harvest. But considering carryout levels and trends of the past several years, expecting basis to reach it's high in late Aug would have been a long shot.
In the chart below I show where I set my basis.
Notes: All bids are for on-farm pick up. Also, I remove the commercial freight rate off of the bids posted by the ethanol plant and shuttle loader from my farm and add back in any dividends I might acquire from selling to either location. I want to compare apples to apples when I look at bids.
My final basis price was middle of the road. I could have done a bit better, but I could have certainly done worse.
The chart also shows basis was higher in early 2017. If I would have set my basis for earlier delivery I would have missed out on my market carry premium, so that wasn't a good choice for me. More details on this below.
Many farmers struggle with market carry. It can be a great way to guarantee additional premium, but to take advantage, I must have the grain sold to capture it.
In November of 2016 I moved my Dec ’16 future position to Sep ‘17 futures and collected 30 cents of market carry (the red X on the green line in the chart below). By spring I set my basis for June/July delivery. Ultimately my basis sale was against July futures. By doing this, I missed/loss 8 cents when I had to rolled my Sep futures position back to July to offset the basis sale I made (the red X on the brown line in chart below). My total market carry ended up only as a net of 22 cents of premium.
As I mentioned above, setting basis earlier would have taken away market carry premium. If I would had moved the corn in April/May I would have lost 17 cents of carry instead of 8. A good rule of thumb, a slightly lower basis with more market carry is usually the better trade.
Overall the market carry I collected was about on the average of what I have collected over the last 10 years.
My final corn cash price:
- $4.18 Futures
- $.22 Market Carry
- -$.44 Basis (farm pickup)
- $3.96 Cash Price
Based upon conversations with some farmers near my farm in southeast Nebraska, many took an average of $3.50 cash on their entire corn crop in 2016, so I'm pleased with my final price.
Grain marketing is not simple or easy. If you want to do it right and minimize your risk, it can be complex and time-consuming. The problem is that farmers have a lot of responsibilities and far too little time. Therefore, the amount of time many farmers should be using to developing a strong grain marketing strategy is sacrificed. Instead these farmers prefer to make it quick and simple. By doing this though, these farmers add significantly more risk to their farm operation without even knowing or understanding because risk is hard to comprehend and define. To complicate this, occasional market timing luck by farmers can lead to false hubris that they have a solid grain marketing strategy when they probably don't.
In all trades for my farm the amount of risk I'm taking on is thoroughly analyzed and understood. By doing this, I may not hit home runs, but I'm getting on base most of the time while avoiding the strikeout. This keeps my farm operation profitable year after year.
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