Market Commentary for 10/6/17
The market is boring right now because there is nothing to talk about. Corn seems to be range bound between $3.45-$3.75 until Thanksgiving and it will take an unforeseen surprise to change it. Beans seem range bound between $9.40-$10.00 through November. For that to change, it will take a big South American weather scare. Everything else is probably "market noise" right now.
The Dreaded Margin Call
Last week I discussed the benefits of forward selling on futures to maximize flexibility and profitability in moving sales over different crop years based on market conditions. This likely made some farmers wince, because they know this could require a margin call if the market rallies. Generally, the fear of margin call keeps many farmers from selling forward using futures.
Sadly, these farmers don't realize they are removing an important marketing tool out of their grain marketing tool box. Eliminating margin call is like telling a baseball player to not swing at anything in the strike zone. A player may do alright swinging at questionable pitches, but they increase their odds on missing and striking out. Just as it sounds silly to tell a baseball player to not swing at strikes, it sounds silly to me to tell farmers not to hedge their grain using futures because they don't want to pay margin call.
Why Should Farmers Not Fear Margin Call?
As a true hedger, I don’t like calling it a "margin call," because that term is most often associated with speculators. A speculator making a margin call is in a bad financial situation because a trade has gone against them . I’m not a speculator. I’m a hedger. And a true hedger making a “margin call” is more accurately just making a finance decision. It’s not a bad thing. Let me explain.
Margin Calls For Hedgers Are Typically A Net Neutral (Neither A Gain Or Loss).
When using the futures market to hedge grain, it doesn’t really matter if I have to make a margin call. Following is an example:
Let's say Dec futures are $4/bu in June and I sell some corn. Then in Aug corn rallies due to a huge weather scare and Dec corn increases to $6/bu. Margin call means I have to have the difference between what I have my grain sold for in futures, and the current CBOT futures price. So, in this example I would need to make a $2/bu margin call to my futures trading account.
This part frightens farmers, because that can be a lot of money. But, there is no reason to be worried, because I’m not losing that money.
Let’s assume that I will harvest my grain in October and take it to the elevator. For simplicity, let's also assume the price in October is still the same as it was in Aug - $6. (the actual price in October would not really matter though). So, I sell my grain for $6/bu cash to the elevator and they hand me a check for $6/bu. At the same time I sell to the elevator, I buy futures back in my hedge account for $6. This buy back keeps me net neutral. I had already sold in June when I picked a value I wanted for my grain. The important part of this example was when I sold the corn for a cash contract, and I immediately bought the same amount in my hedge account, otherwise I would become a speculator. I always have to keep my position net neutral when I sell my crops for cash and have a futures position. Remember, I'm not a speculator, but instead just a hedger. In this case I got out of my hedges as I sold the grain.
When I combine my hedge account and the check for the physical grain from the elevator, I lose $2/bu in my futures account, but I still sold the corn for $6 cash. This is where I net out $4 per bushel, which is where I originally made my sale. At the time I sold in June I thought I was making a good sale. This is the point where I get back all of my margin call money.
I Don’t Have Cash Just Lying Around To Make Margin Call Payments. This Sounds Bad.
Most farmers don’t have a lot of cash laying around. Farmers hedging grain need to work with their bankers. When I work with farmers, I work with their bankers first to make sure they understand the plan and to set up a path for margin calls as a part of a hedging position. This is a very low risk loan for bankers, so they are usually extremely supportive. Many bankers will set up what is called a hedging line that is related, but separate from the operating note.
In the above example I sold futures in June and delivered at harvest (4 months). If the rally didn’t start until August, it would mean a $2/bu loan for 3 months (Aug to Oct). With a typical interest rate of 5% on a hedging or operating loan, this means only 2.5 cents/bu interest for the margin call for those 3 months (math = $2 x 5% / 12 months for a monthly rate x 3 months).
Why Would I Even Do This Then? I Could Have Just Sold Grain To My Elevator And Not Worried About Margin Call.
If corn rallies due to a major drought, you can’t take advantage of increasing basis levels and other premium opportunities unless you use futures contracts or Hedge To Arrive contracts (HTA’s). For instance, in 2012 (a drought year), I received $.80/bu more for my corn in the form of basis with what I sold using futures than farmers who sold corn for a flat price to an end user the same day as me and took the cash price quoted on presells before harvest.
Why Not Use An HTA And Let Someone Else Make My Margin Call?
There are several reasons.
- Benefit #1 - Costs are about the same - I prefer to carry my own hedge because the cost of an HTA is approximately the same price as I will have in my futures brokerage and the interest on any margin call. HTA's costs vary with end users, but they range from 0-8 cents with most 3-5 cents. So in the above example I might have 2.5 cents of interest and 1 cent in commissions to my broker to make the trade. Basically it’s the same cost as what my elevator charges me to handle a HTA.
- Benefit #2 - I'm not locked into any one end user. It allows me to go with the end user who is paying the most at or any time after harvest. It’s not uncommon to see end users have 10-20 cent pushes in their bid in years with short production. I want to be able to take advantage of this premium in the market. I can’t guarantee where the best bid will be 3 months in advance so locking my grain up with an end user now is not something I want to do.
- Benefit #3 - Easier to get out. If I am unable to produce corn (e.g. due to weather), it’s easier to get out of sales by moving them forward with futures to the next year I will produce grain. Most of the time I can actually capture a profit doing this. If I have to ask an end user to be let out of contracts, be it cash trades or HTA’s, there will undoubtedly be a penalty price. Even if the end user offers to move the sales to the following year for free that is a huge loss to me because usually there is extremely good carry in the corn market from this year to next. Currently there is over a 40 cent premium to move sales from ’17 to ’18.
- Benefit #4 - More flexibility - For example, in 2012 when the market rallied above $7, some elevators refused to place more HTAs and in some cases made farmers set basis on HTAs already traded when basis was near their lowest value. This happened because these elevators didn't secure large enough lines of credit from their banks and were forced to liquidate their position. I don’t want to have my profits reduced because of somebody else’s failure to plan ahead. I want to be in control of my money, my bushels, and my profits.
Myth – Making A Margin Call Is Bad
Many farmers may be shocked by this, but making a margin call can be a GOOD thing. Here’s why….
Typically, I don’t price all of my corn at one time, and I doubt most farmers do either. I usually hold some back for potential market rallies. As described above, I have to pay margin call on my priced or sold grain with every rally. But, this means the corn I haven’t priced or sold yet is now worth more. ALL future unsold grain is now worth more. Since I plan to farm well into the future, I have more corn to sell, maybe not this year, but next year I will.
***Margin call means corn you haven’t priced or sold is worth more. Embrace it.***
I Understand That The Math Makes Sense, But I’m Still Too Scared Of The Margin Call.
Many of the farmers I have worked with expressed reservations and fear the first year as they cut several $5,000-$10,000 margin call checks during the months of June and July (despite knowing they will eventually get it back). It can be a lot of money. However, once they saw that not only did they get the money back later, but they also had more opportunity at improved basis levels that their neighbor, who didn’t use futures, didn't get. Typically after the first year those farmers wonder why they didn’t start using futures sooner and embrace margin call.
Don’t let your fear of margin calls keep you from using the biggest marketing tool there is to hedge your grain and take advantage of market opportunities. Savvy farmers understand it and use the tools that are available to increase profits and minimize risk.
Superior Feed Ingredients, LLC
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