Scheve: Why Farmers Have An Edge Over Speculators
Oct 01, 2018
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Market Commentary for 9/28/18
On Friday I drove from South of Lincoln, NE back to Minneapolis, MN, retracing my path from the previous weekend on I-80 and I-35. In just a week there was a difference in the harvest progress, but not as much as I expected. Corn harvest is still moving north at a slow rate, while beans saw a lot of progress.
Unfortunately the markets haven't progressed as well. USDA estimates showed 5% more corn and 10% more beans stored in the bins than the trade expected. The fall harvest is estimated to be a record for both crops, while trade is still an issue for the beans.
Some in the trade were excited that Brazil bought beans for the first time, suggesting this was bullish news. I'm not so sure. The US produces about 33% of the world's beans. If China, who uses 60% of the world's beans, doesn't buy any US beans this year, then the rest of the world will need to buy 90% of their beans from the US. This means Argentina and Brazil would have to buy a lot more beans from the US, so they can ship nearly all of their production to China. The USDA has only dropped US exports by 10% from last year. Export levels must be maintained, otherwise it's not realistic for beans to continue at current values.
Why Farmers Have An Edge Over Speculators
When reading social media or listening to coffee shop talk it’s easy to be convinced that farmers are on the losing end of the market all the time. Some are convinced that speculators are the ones making money.
While it may be the case for some farmers to be on the losing end, savvy farmers know they have an edge that most speculators don’t. The difference….farmers are always raising more crops and speculators can't take advantage of this difference.
Why Is This Better?
It’s better, because when farmers use a scale up sales approach during a rally (assuming above breakeven points with normal size crops) they should be at profitable levels. The higher the rally the more confident a farmer should be that making a sale is correct. Farmers always have more grain to sell. Even if a farmer sells all of this year’s crop on a major rally, they can and likely should start selling next year’s crop too.
Speculators don't look at their positions this way and don't usually have this type of edge.
How Should Farmers Use This Edge?
Many farmers don't understand how to use their edges to help them be more profitable. Following are some examples for a corn farmer’s marketing edge.
Edge #1 – Market Carry - when the price of grain in the future is worth more than current values.
Using market carry and moving sales forward in time, allows farmers more flexibility in accepting some missed opportunity in the market by holding their corn until a time where it is more needed and end users are willing to spend more because of limited supply. Market carry has historically been available in the corn market most of the time. This is especially true when there is significant carryout, like we have today. Inverses, when future months are lower than the current month, happen less often in corn (note, this is not always true of the bean market).
For example, I could sell $3.60 futures today off the combine OR I could store it until next summer and get $3.85 against the July ’19 corn futures.
I could even take this a step further. If there is a rally in the spring or next summer and prices are above $3.85 next July, I could collect market carry again by moving my sales to the following crop year. Historically there is a 40 cent market carry premium year over year when there is significant carryout like the past 5 years. If I moved the July '19 corn sale to July '20 for 40 cents, I would get $4.25 for my 2019 crop, if I stored my '19 corn until Summer 2020. (the math on that is $3.85 40 cents = $4.25) Again if I already have my sales on in futures the actual price levels doesn’t matter. What matters is the spread, or market carry, between contracts months.
If I choose to move my sales that were in place for the 2018 crop to the 2019 crop it would free me up so that I could then sell my 2018 corn next summer at the higher prices of a rally.
This example shows how the availability of future production allows for more flexibility and profit potential in an less than ideal market while leaving upside potential open. If the market rallies, I am able to average two crop years above $4. If the market doesn't rally, I still get $3.85 for next summer shipment. Speculators can't really do this.
Edge #2 – Crop Insurance
Crop Insurance allows me to forward sell my grain to the level of coverage protection I buy with substantially less risk. While crop insurance doesn't guarantee profits, it does guarantee a minimum production level. With price levels below breakeven, farmers suffering from yield loss have little chance of breaking even. Selling forward on good rallies can help minimize loss and provide farmers with an edge. If the production is not there to cover sales that were made the farmer has two options. One, they can use insurance levels to buy back the sales. The second options is that if the market is in a carry they can move their sales forward to the next production year and likely collect a premium that allows them to sell next years corn for nearly 40 cents more than where their sales were in place this year.
Again, speculators don't have these advantages. They fear ups, downs, and sideways markets because missed opportunity for them can mean a straight up loss. Speculators have a lot of risk. Crop insurance reduces farmers' risk in a failed crop year, which allows them more freedom to forward sell and take advantage of market opportunities. Upside potential for farmers in this situation can be much higher.
Edge #3 – Crop Adjustment
Farmers can switch between corn, beans or even wheat based upon the profit potential when planting. Farmers can and probably should even sell their crop at a profitable price even before they plant it. Maybe not all of the crop right away, but certainly a portion, and then continue to be a scale up seller as profits presents itself.
Understand Your Edge
While a bit more difficult and time consuming, if farmers understand their edge in sideways markets, like using market carry, increased profits can be available.
Obviously nothing is a guarantee or works every year and that is why it’s only an edge. Selling too soon can still be a wrong decision, but these edges can help soften the blow of being wrong. I don't know where the market is going any more than anyone else, but I take advantage of all the edges I can to maintain as much flexibility and opportunity to available premiums in the market.
Many farmers don’t think this way. Most of this thought process runs counter to everything farmers have learned or done in the past, but in the long run it has much lower risk for farmers and should have more opportunity for higher profits. The most progressive farmers are using the edge they have to their benefit. They are choosing NOT to be a speculator.
Superior Feed Ingredients, LLC
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