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Market Commentary for 1/11/19
Due to the government shutdown this month's USDA report, arguably one of the top 3 reports of the year, wasn't published. There will likely be more market volatility until an impartial number can be released by the government again.
Many in the trade are assuming the national yield has decrease up to 1 bushel/acre on corn. Plus, demand is likely to be steady, which would mean a slight carryout reduction. Carryout hasn't been this tight in 3 years and the stocks-to-use ratio, which is carryout / demand, is at a 4 year low. All of this should mean higher corn values, but the market isn't trading those type of levels.
Corn vs Bean Acres
With Nov beans around $9.50 and Dec corn around $4, it's not clear if as many acres will switch from beans to corn for 2019. Corn needs to buy 3 - 4 million acres from beans and that might not be as likely right now. Are corn futures too low or are bean futures to high? Basis levels throughout the US indicate bean futures are probably too high and corn is "normal."
It's important to understand the corn / bean price ratio (bean futures divided by corn futures) when it comes to planting acres. If the ratio is above 2.45 : 1, prices favor planting more beans. If the ratio is below 2.35 : 1, prices favor planting more corn. With current prices ($9.52 Nov / $4.01 Dec) the ratio is 2.37 : 1, so there is not an overly strong indicator to plant corn today. But back on 11/1/18 when farmers were making seed and fertilizer purchases, the ratio was 2.26 : 1, indicating farmers should consider strongly increasing corn acres. While this can help with estimating, no one will know the actual planted acres for at least another couple of months.
Bean prices continue to surprise me with nearby values above $9.00. In talking with farmers and grain elevator managers throughout the country, it seems a lot of beans were stored, and now with the "Trump Bump" money available, many farmers may wait and hope for either $10 futures or see what summer weather is like before selling at lower levels.
Many in the trade are focusing on the dry Brazil weather and anticipate a yield reduction. While the yield potential has suffered some, the overall production is still expected to be similar to last year.
Argentina for me is more of a wildcard this year. Last year Argentina suffered the worst drought in 40 years and current estimates indicate they may raise 45% more beans this year If that happens, there could be too many beans in the world to support higher values.
Lack of demand from China also isn’t helping US bean prices. While trade talks earlier this week sounded promising, nothing concrete has been announced. It seems like beans are fighting an uphill battle in the US, but if farmers continue to hold their beans, the market won't likely go down all that much. I suspect beans could be range-bound for a couple of months.
Answering Reader Questions - Fear Of Missing Out And Margin Calls
For the past few weeks I've written about selling straddles, call options and margin calls. During that time I've received several really great questions from readers, so I wanted to provide some answers.
Question #1 - "If The Calls Or Straddles You Sell Trade Higher, And You Don't Get To Lock In a Sale And The Market Drops, Don't You Miss Out?"
This is the reason why selling calls and straddles isn't always a perfect solution. If the market does a run up, and then falls suddenly, I could miss out some. That's why I limit the amount of production I produce in these types of trades to about 33% (i.e. 33% chance the market will stay sideways, 33% chance it will go up, and 33% chance it will go down). That way if the market rallies, I still have significant production available to make straight futures sales when my desired levels are hit.
Question #2 - "How Do You Make Money On Futures Sales That You Have Already Made If The Market Goes Up After You Make Them?"
You don't. Similar to making cash sales to end users, once a futures sale or call that gets exercised is made, you can't add to the sale (even if the market rallies). That's why I fully understand and am willing to accept ALL possible outcomes when I make EVERY single trade. Plus, I usually only make trades with 5-10% of my production at a time. That way if the market goes down, I'm happy I did something. If the market goes up, I only sold a little bit and have more to sell. For me it's better to do a little something, than to do nothing waiting and hoping for a rally.
Now....you could avoid being locked into a price by gambling and buying a call hoping the market continues to go higher so you can increase your profits. But, if that call doesn't increase in value, and/or it expires worthless, then you lose money. That's why buying calls for a producer is gambling. It's somewhat of a controlled gamble because you have limited downside, but the vast majority of options expire worthless, so most grain producers will lose money when buying calls.
Question #3 - "I Don't Understand How I Will Be Able To Fund Any Margin Call When I Have To Borrow Money To Put The Crop In The Ground"
This is a common fear among farmers and a few bankers too. There is only so much money that can be borrowed by any farm operation.
However, when banks lend money part of the process is assessing the debt to asset ratio. One asset they look at is the value of the grain in the bin today. Banks also look at what next fall's prices will be for next year's likely production. Both of these numbers are part of the process the bank uses to determine how much they can lend for a margin call loan.
Margin call is required if the market rallies after any futures sale are made. But it's important to remember.....if prices increase, the value of the grain in the bin and next year's production will ALSO go up. This means the underlying assets have increased as well to offset the required margin call. Many banks limit the amount of forward sales to the farmer's insured crop levels. So if a farmer has 80% coverage, then likely the bank will limit the sales to 80% of insured bushels for any sales against the 2019 crop. Again this helps protect the farmer and the bank in the event of a margin call and lack of production.
I've worked with many banks to help arrange margin call loans for farmers and their lending policies vary. Some banks view margin call as a 1 to 1 ratio on this price relationship, while others can't do 1 to 1 but instead some predetermined percentage of it.
Most banks I work with set up a hedge line separate from the operating note. This money can only be used for hedging purposes and not any other part of the operation to avoid any confusion and protect both the farmer and the bank. To set up a hedge line nearly all bankers require a written marketing plan and/or the hedging tools and process the farmer plans to use as well as monthly or quarterly check ins to monitor progress.
The good news is most farmers have a favorable debt to asset ratio and can participate in this type of hedging plan with their banks. It's best to talk with your banker first to make sure you're both on the same page. Most banks are familiar with hedging and are supportive of hedge lines for margin calls. However, there are still some bankers who don't fully understand hedging and how much hedge lines can benefit both the grain producer and the bank. If you're banker doesn't offer hedge lines, you should consider finding a banker who does. Typically these types of loans are a win-win for farmers and bankers when it comes to risk management.
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