Scheve: Understanding The Relationship Of Market Carry To Basis Values
Sep 10, 2018
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Market Commentary for 9/7/18
Wheat futures continued their collapse this week, down 16% in value since last month. In the last 3 months, corn is down 12% and beans 20%.
A record harvest is expected and many farmers are sitting on a lot of unpriced old crop. This in turn is creating logistical problems everywhere. Without a huge surprise yield reduction in this week's USDA report or a trade fix with China, the market will probably stay at these low values through harvest.
Understanding Market Carry’s Relationship To Basis Values
In last week's article I reviewed if there was a better basis opportunity to sell my 2017 corn earlier this year. My explanation confused a few people. Here is recap of what I wrote last week:
I had the opportunity to set the basis at -.21 the Sep instead of the -.43 the Dec that is posted today. However, if we apply the value of the spread at 15 cents to the Sep basis we find that -.21 the Sep is/was actually -.36 the Dec. So really all I have seen is a drop in basis of 7 cents from the best value this summer. Either way its remained a better decision to hold the grain until after harvest.
When comparing basis values, I always take into consideration the market carry between future contracts. In the case last week, there was a 15 cent market carry from Sep to Dec futures. With the best basis value of the year against the Sep being -$.21, the equivalent value of basis against the Dec would have been -$.36, because the 15 cent carry needs to be considered as well.
Currently basis is trading at -$.43 near me, which is only 7 cents worse than the best bid this year. This isn't as low as I would have expected given recent market conditions, but illustrates why market carry is very important when looking at current or even forward basis levels.
Looking at New Crop values
One of my local end user had the following basis level bids posted last week:
- September -.43 Dec
- October -.43 Dec
- November -.32 Dec
- December -.18 Dec
- January -.28 Mar
- February -.25 Mar
Every year most end users' December basis bids tend to look better than their harvest delivery bids. Having a better December bid vs harvest makes sense. End users get flooded with grain during harvest and they need to entice someone to hold grain until harvest is complete.
But, there is also another trend of most end users having a lower January basis bid compared to their December bid. For instance, this end user has a -$.18 bid against December futures and a -$.28 bid against the March futures for January delivery. At first glance it might seem like the December bid is much better than waiting a month to price the grain for January delivery. But is it?
To judge accurately the market carry between December and March futures needs to be considered. Currently, the December to March futures spread is 12 cents. So, farmers with a hedged position, and using futures, can "roll" their sales from December to March and collect 12 cents. So, this means an -$.18 against Dec for a December bid is the equivalent of -$.30 the March futures for December delivery. When market carry information is considered, the December bid is actually worth 2 cents LESS than the January bid. The -$.18 December bid isn't as impressive as originally thought.
This doesn't necessarily mean I should be holding my grain until January to make a sale though. There is also the interest cost (explained last week) to hold the grain that needs to be considered too.
Assuming 5.5% loan interest on the current corn cash value of $3.09 (i.e. the cost to physically move, sell and collect a check on the corn in the bin and pay down my operating loan) means it costs me 1.4 cents/month to continue to hold it in storage. (Math: $3.09 x 5.5% = 17 cents for a year / 12 months = 1.4 cents per month)
Once I include the interest cost for either selling in December or January I find its nearly the same value. That opens up another list of questions that pertain to when I should set basis and move any grain I have in storage.
Should The December Basis Be Sold Now Or Not?
There are a lot of variables to consider when making this decision. Some of the questions that I will begin to ask are:
- Do I need income before the end of the year?
- How am I going to store the grain or what kind of conditions will the grain be in at the end of the year?
- What are the market dynamics in the area?
- Are there any market conditions to consider (i.e. crop size variances locally compared to the region)?
- What are the chances basis will rally beyond -$.30 against March futures in December or the first couple of months in 2019?
- Historically, what have normal basis levels been in the area?
Then there is the question of what will the Dec/Mar futures spread do. Could it widen from the current level of 12 cents out to 15 cents like the Sep/Dec spread did last week. Or might it narrow to 10 cents because no one is selling corn at low levels after harvest. A 2-3 cent change in the spread in either direction could change the decision of selling either in December or January.
So before jumping on a seemingly good basis price, it's important to consider the market carry before making a decision. Sometimes bids that look to good to be true might not be all that great at the end of the day. Understanding market carry’s relationship to basis values can improve my bottom line.
Superior Feed Ingredients, LLC
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