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Market Commentary for 7/16/21
The USDA had no surprises for corn and beans last week. Now the market will wait for national yield estimates in the August USDA report. 25% of the corn belt is dry, so the next 2 weeks will be critical for the national yield outcome and price direction. The price potential range is still very wide.
Carry versus Inverse Markets
A market carry is when a nearby futures contract month’s price is lower than a later month’s price. On Friday, December corn closed at $5.52 while March closed at $5.59. This indicates corn supply during and after harvest is expected to be higher than demand usage, so the market is encouraging hedgers to store the grain for later use by paying them the carry spread.
Inverses are when the nearby futures contract month’s price is higher than a later month. For instance, on Friday September corn was $5.56 while December was $5.52. This suggests supply is low now, demand needs to be rationed, or bushels need to come out of storage because there isn’t a price incentive for hedgers to hold grain.
Inverses encourage bushels out of storage, because hedgers will incur an expense equal to the price spread between future contract months to roll their hedges forward. Additionally, there is still the interest cost to store grain in the bin too. Therefore, in inverse markets hedgers often set their basis, get out of their futures position, and move their grain out of storage.
Historically, the July/September corn spread has a carry. The following chart illustrates this, showing the July/Sep corn spread from 2014 through 2020. The green dotted line represents July and September futures contracts being at the same value. Above the dotted line, the market is in a carry and paying to store the grain. Below the line, it is in an inverse, and it will cost a hedger money to store the corn.
In some years, the spread difference between the July/Sep is lower until the crop is planted. After planting, the spread usually moves to a larger carry, especially if the crop is growing well.
There are only 2 recent years where the July/September spread had an inverse – 2013 and 2021, shown in the chart below.
The 2013 inverse followed the 2012 drought, and the 2021 inverse followed the unexpected increase in Chinese export demand over the last 10 months. Often inverses get larger when supply is tight in the near term, but an upcoming harvest is expected to be large. Conversely, inverses tend to shrink if new crop yields are in question.
With the recent July/Sep spread inverse, many commercial elevators, and farmers with hedged grain in the July contract, did not want to risk taking a loss with the spread by rolling their positions to September. Therefore, most would have set their basis by the end June.
Trade #1 – Rolling Futures into an Inverse:
While there has been significant risk in the July/Sep spread for hedgers since Christmas, there was less concern about the March/July spread during the winter. By late February, it was even uncertain if the market inverse would continue because of export pace uncertainty and unknown South American corn production levels. The dotted white line in the chart below represents no price difference between any of the spreads (i.e., above the dotted line is a carry, below is an inverse).
The chart above shows a small inverse started in late December 2020 but worked back up to near even through mid-January. However, as China bought more grain and futures went higher, the spread inverse got bigger.
By early February, I had 75% of my corn position still in the March contract, so I needed to either set my basis or roll my futures to a different month. Historically, in a tight year basis values increase until summer, so waiting to set my basis at higher values could increase my profits. However, rolling a hedge forward in an inverse means I must take a loss equal to the inverse spread. Therefore, I was uncertain if the basis increase I expected could offset the spread inverses/losses.
If I rolled my position forward, I basically had two choices: the March/May spread for a 2-cent inverse/loss or the March/July spread for nearly a 14-cent inverse/loss. Historically, in tight carryout markets the May/July spread has eventually resulted in big inverses. Therefore, to minimize my risk I rolled my remaining corn hedge position from March to July. Even though July would cost me more to roll my hedges to, it allowed my more time and flexibility to set my basis versus rolling to the May contract.
This trade was not necessarily at the high or low end of the March/July spread trade as noted by the red X in the chart above. However, rolling to the July early ended up being a good decision because the May/July spread inverse increased substantially in April.
Trade #2 – Final Corn Basis Trade For 2020 Crop
In late February basis values were -20 picked up on my farm. So, the question now was if basis values would rally more than the 14-cents I spent to offset the market inverse from Trade #1. The below chart shows basis values near my farm from mid-March through the end of June against the July futures.
As the chart above shows, in late April, 2 months after rolling my futures to the July, basis values DID increase significantly in my area and several grain buyers were willing to pay me +25 cents the July futures picked up on my farm. This was 20 cents better than any posted bid near me, including freight, and 45 cents better than the basis levels I sold in February. So, I set my basis at +25 with multiple buyers.
While my late spring basis values were much higher than my levels in February, I still need to account for the 14-cent inverse cost to roll my hedges from March to July. In the end, I collected 31 cents rolling my hedges and waiting for better basis over selling all my grain in February.
Also, I’m glad I didn’t wait longer to set basis, because as the chart shows basis values started falling significantly in late May. This is likely due to hedgers with July positions waiting until the last minute to see if the inverse turned around or if basis values improved before making the decision to roll positions to September or set their basis.
2020 Corn Basis Final Thoughts
Ultimately, rolling my hedge forward in trade #1, taking the 14-cent inverse hit, and then taking advantage of the 45-cent basis rally for a net 31-cent basis improvement from the winter trades was the best opportunity of the year and a good decision for my farm. In hindsight I should have saved all my grain for these trades, but with what I knew at the time, minimizing my basis risk in early February made sense. Even combining all my 2020 basis trades, I am still more than 20 cents higher than what I usually expect to get from my typical basis strategy in a carry market on my farm each year.
Because of the July/Sep inverse spread I didn’t hold any grain over this year. The market is telling everyone through the basis and spreads to not physically store any corn in bins from this point forward until the middle of harvest.
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Jon Scheve
Superior Feed Ingredients, LLC
jon@superiorfeed.com
