A look at market carry and spreads

Early last week the market was positive, but it turned negative at the end. Right now corn seems range bound from $3.30 to $3.50. Slow harvest progress has helped keep prices from testing the lows. This week however looks to be a wide open window for harvest to move forward for the entire Corn Belt.

As harvest continues, both corn and bean yield reports are increasing. Soon the South American weather will be a focus. Perhaps the USDA report will provide information to move stagnate prices.

 

Market carry and spreads

In order for farmers to be as profitable as possible, they need to understand how cash prices are derived for their grain. I frequently mention that cash prices combine futures, basis and market carry. Futures are easy to understand and more and more farmers are paying attention to basis. Still, market carry eludes many farmers.

Market carry is a function of increasing spread prices between futures contracts. Typically, corn has a “carry” when futures are worth more later than nearby months. Essentially, spreads are how the market “pays” for someone to store grain until its needed. The wider the spreads the more the market is “paying” someone to store grain.

Market inverses happen when a future contract is worth less than the previous contract. This happens when the market is demanding grain be moved as soon as possible, rather than storing it. Interestingly for beans, currently there is a carry in the market until July ‘17 and then an inverse from July ’17 until Nov ’17.

Corn spreads tend to move slowly, one to two cents per month is typical. Bean spreads move more quickly, it is not uncommon to see five cents per month. Since the amounts are so low, it’s difficult to see spread movements daily (or even weekly). However, those little extras can really add up when margins are tight.

 

Market Action

Beans

Last week I moved my beans hedge position, my average sale prices are $9.45, which are in the Nov ’16 futures:

  • 70% moved to the Aug ’17 futures for a 22 cent premium
  • 30% moved to the Nov ’17 futures for a 5 cent premium.

 

Why did I do this?

I won’t be moving any beans at harvest. I will instead be storing them, waiting for basis to increase after harvest probably sometime in 2017.

I had other choices for moving my bean hedge instead of Aug (22 cents) or Nov (5 cents):

  • Jan (6 cents)
  • Mar (12 cents)
  • May (17 cents)
  • July (23 cents)

 

So why August?

Once harvest is over, I suspect farmers won’t be ready to sell more beans, waiting instead for a run up in futures. Some may be anticipating a repeat of spring 2016 when futures went $3 per bushel higher, this should keep demand tight. Also, beans are frequently affected by South American (and North American) weather scares in the spring and early summer causing short-term market inverses. In fact, this last summer a weather scare caused an 18 cent inverse from Jul to Aug. That’s why I chose August instead of July, if a similar weather scare causes an inverse from July to Aug, I can take advantage of that opportunity (on top of the 22 cent market carry I’m already getting).

Even if I don’t hold my beans until Summer I can wait and see if the spread between March and August narrow in from a current 10 cents to maybe even money or a 5 cent premium. If this occurs I can move my beans to market earlier for more than I would have received just rolling my position to March.

I analyzed if I did this same trade for the last eight years, and the largest potential loss for this type of trade was about 3 cents but it could be as high as 7 cents. I’m willing to risk losing 3-7 cents to potentially make an additional 18 cents.

 

So why November?

The downside risk of the Nov ’17 position would be if there was no South or North America weather scare through next summer. While it’s unlikely that would happen, I will have missed out on 25 cents of market carry. Also, the spread between Jul ’17 and Nov ’17 would likely go from a 20-cent inverse to a 12 cent carry. This would mean a potential 32 cent loss and 25 cent missed opportunity. Since that is a lot of risk, I only exposed 30% of my production. The upside of this trade could be as much as $2 per bushel. Last year we saw $1.80 premium and in the last couple years we have seen over $2 and even $3 per bushel. I’m not expecting anything that large but my upside does look very promising for the added risk.

 

Corn

Early last week I sold 5% of my corn production against Dec ’18 corn futures at $4. While I’m not sure which marketing year I will use this sale, I know I want to be a seller of $4 futures with the information I have today. Once I know the spreads next summer, I’ll make the decision to either move this sale back to 2017 or leave it in 2018. Last year this trade would have allowed me to use the futures sale on old crop, new crop or the year after next all at the same level. Again this trade gives me upside potential while giving me floor protection at values I feel are good levels to sell.

 

Market Carry and Storage — corn vs beans

Why do experts suggest storing corn and selling beans?

It’s a function of the spreads relative to the value of the grain and the interest to store. Farmers need to look at their operating loan value (typically around 5%). Take this times the value of grain (let’s estimate $3.40 for corn and $9.75 for beans). This would mean it costs 1.4 cents per month to store corn and 4 cents per month for beans.

The market is currently paying 24 cents to hold corn until July and its paying 20 cent to hold beans until July. Even if both were paying the same price it’s too expensive in interest to hold beans in the bin.

 

But the price of beans could rally $2 and corn may only rally a $1

True, but that is a futures issue not a spread or basis issue. Farmers who store beans hoping for a futures rally are marketing poorly and ineffectively. On the surface it’s easy for farmers and it seems like it works, but there are better ways to capture a market rally.

It is almost always most profitable for farmers to have 100% on-farm storage. If this isn’t an option, store all the corn possible on-farm. If there is additional storage available, store beans. If beans aren’t completely priced and the only options is paying for storage, and one wants to continue to wait for upside potential, then a re-ownership plan through futures is a better strategy than paying for commercial storage.

 

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

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