Scheve: Should Farmers Be Bullish Or Bearish Beans?
Feb 19, 2018
Market Commentary for 2/16/18
On Monday the bean board rallied due to limited precipitation in central Argentina. As the week progressed beans drifted slightly higher as everyone waited to see if it would rain. The difference between rain and no rain could mean a significant market move in either direction.
Should Farmers Be Bullish Or Bearish Beans?
There is often conflicting information in the trades on whether farmers should be bullish or bearish. Usually there are reasons to be both. Therefore, I will often write down the reasons why the market could go up or down when developing my marketing strategy. I can then use this information to determine what I think is most likely so I can make the best trades possible given the information I know at the time.
Reasons To Be Bearish Beans
· Seasonally the South American weather market is approaching an end
· US carryout is the highest in 10 years and it’s still increasing due to slow exports
· World Stocks are still at high levels
· $10.20 beans has better returns than $4 corn for the average US farmer
· Speculation increasing that US farmers will plant more beans in 2018
· A possible trade war with either Mexico or China (or both)
Reason To Be Bullish Beans
· Dryness persist in Argentina
· Delayed harvest progress in Brazil
· Beans rallied on the negative USDA report the previous week
· Dry conditions in the Southern US plains
· Unknown duration of La Nina
· Unknown US summer weather
· Increased worldwide protein consumption year after year
· World stocks, while high, are starting to descend
On 2/9/19 I sold the balance of my 2018 bean production against Aug for $10.07, making my overall average $10.10 against Aug futures.
Why Aug Instead of Nov?
August was trading 5 cents higher than Nov. I also think the US carryout will continue to stay at a 10 year high. If this happens, there will be a carry in the market (when nearby month is lower than a future month). If this happens, I can roll my Aug positions to the Nov and it could add an extra 15 cent profit to my trades, meaning a possible $10.25 against Nov eventually.
What Is Your Spread Risk?
While this type of trade has worked well for me in the past, it's obviously not guaranteed. My risk is if there is a major production issue in Argentina forcing large-scale reductions, which would decrease overall world and US carryout. This happened in 2016, and a trade like this that year would have been a 40 cent loss. So if a similar situation happened this year, it would mean my current $10.10 average could go down to $9.70.
How Likely Is It That Argentina Will Have Production Issues?
It's uncertain and forecasts vary daily. A week ago it was less likely, but this week dryness became more widespread.
How Bad Would The South American Crop Need to Be To Cause Massive Buying In The US?
The original USDA estimates expected Brazil to produce 112 mmt (million metric tons) and Argentina 54 mmt, totaling 166 mmt combined. With favorable weather conditions in Brazil, but poor conditions in Argentina estimates are generally ranging at 158-168 mmt.
One mmt is just under 40 million bushels of beans. Current USDA carryout estimates show 540 million bushels at the end of the marketing year. Assuming world demand remains the same, a reduction of 3 mmt would likely have minimal effect on the market, while 8 mmt less production could have a significant impact on prices.
Why Sell 100% Of Your 2018 Production Now?
Honestly, that is a question I've been wrestling with for the last few weeks. There are three big reason.
Likely Bean Acre Increases - I think it's likely farmers will increase bean acres in 2018. Many estimates suggest increases between 1.5 - 3.0 million more acres than 2017. At these higher levels, a weather scare would be needed in the US over the summer to prevent lower prices.
South America Conditions - The 2018 Argentina bean crop is one rain event away from being significantly large. This could hurt exports for the US crop forcing a larger carryout. A supply disruption in South America is really necessary for a significant price increase at this point.
Guaranteed Profitability - I know beans are profitable now and corn is not, so I want to lock in prices.
Are You Concerned To Be 100% Priced This Early?
Yes, like all other farmers when I sell I'm concerned I made the wrong decision and prices will go up. But, I have to limit my farm operation risk and by selling my beans now I can reduce my risk exposure and take guaranteed bean profits. Basically I sold because today I'm MORE worried that it will rain in Argentina and bean prices will plummet, than I am missing the top of the market.
I also think of it another way. I still have 50% of my 2017 corn crop and 75% of my 2018 corn crop unpriced. If beans do rally, they're likely to pull up corn prices too. For instance if beans increase $2/bu, it's reasonable to assume corn would increase 40 cents also to keep the price ratio relatively close. Since the corn market price is currently below my breakeven points on my corn a 40 cent corn rally would be needed to take me to profitable levels.
What's The Corn/Bean Price Ratio?
On average when farmers produce both corn and beans, they produce 3x more corn than they do beans. This ratio varies across the Midwest (it's about 4x on my farm), but it's a good rule of thumb. The price ratio for futures usually falls in line with this production ratio - 2.2-3.0 (currently it’s about 2.5). So, if beans hit $12 then corn would likely adjust to $4 or maybe even $4.50. Knowing that if bean prices rally significantly, there is a good chance corn prices could go up too and I'll be able to sell my unpriced grain eases my mind a bit on my decision.
Why Not Just Use Options So You Can Participate In A Big Rally If It Comes?
I thought about doing that too. I considered buying $10 puts for 50 cents to take advantage of a rally, but when I did the math, it didn't make sense for me. If I did this I would receive a guaranteed $9.50 with unlimited upside potential (i.e. hoping for higher prices). But even if prices increase to $11, I still have to subtract the cost of the call (50 cents), meaning I would only get $10.50. This is slightly better than $10, but if prices don't go to $11, which is not a guarantee (and I'm not very sure even likely), I'm stuck at $9.50.
I also considered buying an $11 call for 20 cents when I sold my beans to take advantage of a potential future market rally, but again I thought my odds were low that prices would surpass $11.20, which would be needed to warrant spending 20 cents on the call. The cost of the call always needs to be subtracted from what I sold, and in this case it would have placed me below $9.90 on my guarantee. I didn’t think the odds were enough in my favor to do it.
While I always consider buying options in my marketing strategy, I try to avoid trades where I have to hope prices go higher to make a profit because I usually end up losing on them.
So Many Bean Unknowns
Even without unpredictable weather events, there are many unknowns in the market. This week I became concerned after seeing milo (sorghum) basis drop 70 cents the day after China announced they were looking at US trade policies on it. China is the world's largest bean buyer, so there is always the possibility for market manipulation. Realistically, it’s probably a long shot that China would want to put a tariff on beans given their growth potential in protein consumption, but it’s difficult to know how they view trade on other products such as metals or finished goods that could be a target of the US administration trade policy.
The Market Rallied A Little This Week. Are You Disappointed You Sold When You Did?
Sure, in hindsight I wish I would have waited a little to pick up an extra 25 cents, but I had no way of knowing that would happen. It could have just as easily gone down that amount. I remember a week last July when I didn't sell corn because it looked like the weather would be dry and prices had to rally. I wish I would have sold corn on that Friday in July before the widespread rain happened and prices never recovered.
It's extremely difficult to know when the right time is to sell. There are always reasons why prices can go higher and reasons why they can go lower. On top of that, weather is unpredictable, hence why corn and bean prices are unpredictable. I can't control any of that, so I focus most of my time on what I can control. In this case:
- I will ALWAYS have more crop to sell
- If I know my breakeven points, then I know what price I need to sell my grain
- Figure out how to hit that profitable price point using all the marketing strategies available to me.
- It's pointless to dwell or beat myself up when I don't hit the top of the market. No one does every time.
Superior Feed Ingredients, LLC
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