Scheve: Capturing Carry and Paying for Storage
Dec 03, 2018
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Market Commentary for 11/30/18
For the 1st time in 9 years, December corn on the last day of November traded higher than the last day of October by 3 cents. Looking forward, 7 of the last 8 years, March corn eventually traded at a higher value than where it was on the last day of November. The rally was more than 25 cents 6 of those 7 years. Following the 2012 harvest was the only year when prices didn't rally, and after the 2015 harvest March futures only rallied 9 cents.
While obviously historical trends aren't a guarantee, I think this suggests there is opportunity in the corn market.
This was written before the meeting between Presidents Trump and Xi in Argentina. The outcome of that meeting will have a profound effect on the markets going forward.
Market Action – Capturing Carry and Paying for Storage
This week I rolled my December futures sales to July to take advantage of the 27 cent market carry available in the market.
What Does This Mean?
I bought my December futures back and immediately sold the July contract. When I do this the actual values don't matter, just the spread amount. This 27 cents is now profit that I can add to my bottom line for grain that I will hold in storage until summer. In simple terms, I'm following the first rule of business - I'm buying futures at a low price and immediately selling futures at a higher price. An important note, I can only take advantage of market carry if I have sales in place already.
Capturing the market carry is one of the best ways I can guarantee additional profits for my farm operation with very little risk. Despite so many benefits, some farmers are hesitant to do it. Following are some questions/concerns I've heard.
I Just Prefer To Make A Cash Sale To An End User When Prices Rally Instead Of Doing It Your Way
That's understandable and usually much easier, but I've found taking the easy route in grain marketing usually means sacrificing profit potential. For example, when I made the sales against the December futures detailed above back in May, Dec futures were above $4.20. At that time, the spread between December and the July contract was only 16 cents, compared to the 27 cents I got this week. Also, the basis last May at my local end user was 3 cents lower for July '19 shipment than the bid this week.
So, had I made a cash sale last May for July delivery I would have missed out on 14 cents:
- Market Carry: 27 cents - 16 cents = 11 cents less
- Basis: 3 cents less
- Total: 14 cents less
That's why I never make cash sales. The three factors that make up cash prices - Futures, Basis and Market Carry - are never all at their highs at the same time. Each has its own seasonality and factors that determine their value. So, by shifting my grain marketing strategy to maximize the profit potential of each factor independently, I can take advantage of more opportunity in the market and minimize my risk exposure. For the average farmer raising an average yield, that could mean $25/acre more breaking the parts of the trade out. (178.5 /bu yield x 14 cent premium)
What About Cash Flow Holding Corn Until July? Why Not Take Your Great Corn Price Now?
I can make 3.85 cents per month holding my corn until July (27 cents / 7 months). Current interest rates on lines of credit are around 5.25%. With $3.30 cash values in my area, holding corn costs me 1.44 cents/month (5.25% x $3.30 / 12 months = 1.44). So I 'm still making over 2.41 cents/month holding my corn and not paying my operation note. That is nearly 17 cents of profit (2.41 x 7 months).
Note: I can only do this if my grain is already sold and my banker is on board. In my experience, bankers are happy to extend the loan when these numbers within a plan are provided to them.
What About Coring Bins to Keep the Grain in Condition?
I’m always in favor of coring bins out in the winter to make sure the grain is kept in good condition. However, the market incentives me to wait as long as possible and to move the least amount I can. When the time comes to core my bins, I'll analyze how it will affect my hedge account and the carry I can get compared to moving grain earlier or later.
What Is Your Plan Now?
I want to maximize my basis profit potential. So far in my area, the nearby basis has improved 19 cents from the harvest low. The basis values at my local end user against the Dec and July futures were the same. 8 of the last 10 years basis values in my area improved another 10 cents by waiting longer. The years it didn't improve followed the large harvests of 2009 and 2016. Historical performance is not a guarantee of future results, but the odds are in my favor of waiting for basis improvement down the road.
How Much Does Storing Corn Really Pay?
After interest, my market carry net profit is 17 cents and basis has already improved 19 cents since harvest. That's a total of 36 cents I could lock in right now. That is above my bin payments on my 7 year loan. Building bins is the best ways for my farm operation to increase profits.
What About The Corn You Haven't Sold?
I've had some unpriced corn the past two years where I can't capture market carry on all of my corn production. This year I have about 50% hedged so far. Not only have I missed the market carry opportunity on half of my crop, but I'm also still paying interest on the grain while waiting for better prices. If I manage to sell some corn against the March, and then hold it in the bins until July, I could still collect about half the carry that I collected on the December to July spread. It's a good lesson on why it's so important for me to be an aggressive corn seller before harvest.
What Will You Do With Your Unpriced Corn?
I'm not sure exactly. Historically prices rally between now and the beginning of March. So, I need to be prepared for any opportunity available to sell, but I also have several different options positions working if prices don't rally. This is why grain marking is so difficult. Nothing is certain and trying to hit the high can be extremely costly.
There is a lot of profit potential available in breaking out the factors that make up cash prices - futures, market carry and basis. By maximizing the potential of each factor independently I can maximize profits and minimize risk. For market carry, I can only take advantage if I have my corn sold. So, that means I need to make every effort to sell as much grain as possible before harvest. I need to be more aggressive selling than in the past and avoid waiting too long, hoping prices go even higher. I have to remember that if prices do go higher, I always have more grain to sell. If I think about it that way, I'm never missing out on a rallies, just delaying them to a different production year.
Like this article? Check out more from Jon Scheve.
How I Collected 65 Cents On 10% Of My Corn Production With 4 Options Trades
How I've increased My Farm's Profits Selling Calls
Why I Think Buying Calls Is Gambling And Why I Avoid It
How I Collected 18 Cents On Some Of My Corn In A Sideways Market
Superior Feed Ingredients, LLC
9358 Oak Ave
Waconia, MN 55387
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