Collecting on the carry

Beans

On a positive note, beans rallied early last week due to palm oil prices increasing to highs not seen in several years. This increased demand for soy oil as a substitute in some Asian markets.

On the flip side, the USDA report published last week was bearish. National yield averages were a bushel higher than last month’s USDA report. This means that exports will need to remain strong to relieve a potential burdensome bean carryout. Unfortunately, recent global news also isn’t positive. There are rumors that China may be capping speculative commodity buyers. Also, after another corruption charge in Brazil, their currency dropped in value. This will likely keep South American beans cheaper and put pressure on the market.

 

Corn

The USDA report last week shocked many as the national yield estimate increased back over 175. At this level, a 2.4 billion carryout is likely. Still, prices stayed $3.40+, which is a positive sign long term.

Exports, feed demand and ethanol can’t slow down, or prices will likely falter. With the high yields across the Midwest some farmers are having trouble unloading corn as harvest finishes. Elevators and ethanol plants are reducing hours and lines are long (up to four hours in some cases). Unfortunately, many farmers have less than 30% of their crop sold, so any rally will most likely be met with many farmers selling, especially as creditors start calling as farmers crawl out of the combine.

 

What’s next?

With the election over and the Nov report behind us, South American weather will be the hot topic for the next two months. Still U.S. weather also continues to be a concern. So far in Minneapolis temperatures haven’t hit freezing yet, and it may not before Thanksgiving, which has never happened before. I’ve never mowed my lawn in November, which I did today. Green grass across the Midwest reduces demand for cattle feed. This potential loss in demand isn’t something the grain markets need. Long-term weather forecasts suggest a bitter cold winter in the upper Midwest, but these forecasts as with lots of other predictions this year have been very unreliable.

 

Market Action

All year I have been making sales for the corn I just finished harvesting against Dec ’16 futures. Since the market is paying me to hold, I don’t want to deliver my corn in Dec. So I have to be out of the Dec ’16 futures by the end of the month.

 

“What do you mean?”

Currently the Sep ’17 futures contract is a 30-cent premium above the Dec ’16 futures contract. So, I bought all of my Dec ’16 futures sales back. Then I sold the Sep ’17 futures at the exact same time. In other words, I “rolled” my position forward.

 

“What about the price? I don’t like prices right now.”

Farmers need to understand that the price on the Dec and Sep futures isn’t as important as the spread between the values. Many people get caught up in the actual values, thinking money was made or lost in their hedge account based upon the current and/or future price. However, since I have grain in the bin that is not sold, I’m still completely hedged at the same values. The money made or lost in the hedge account doesn’t mean anything yet in the bigger picture. What does matter is the extra 30 cents I pocketed for now.

 

“So you keep the 30 cents?”

Probably not all of it. I’ll have to move 15% to 20% in early winter to core out my bins, so I’ll have to move some of this sale back to Mar futures. This portion will likely reduce to 10 cents premium. Also, I may not hold all of the remaining grain until Sep. I may move some in June or July, which would likely be about 7 cents less (resulting in only a 23-cent premium).

 

“So, why did you pick Sep?”

The last two years I actually “rolled” my hedges forward to July. This year the premium was 23 cents. In 2015 I received 18 cents to roll to July. In the last 8 years I did this trade, I’ve averaged around 24 cents.

I selected Sep this year because I’m expecting the spread between Sep and July to narrow. I think there is a good chance that farmers won’t sell and the spread between the two months will tighten. If this happens, I’ll pick up a few more cents in the spread when I move my corn in the winter and early summer. There is a chance that I might hold my corn until Aug or Sep and this move would save me some brokerage costs down the road. The bottom line is I feel I have more options later by rolling to the Sep now.

To be fair, the spread could widen a few more pennies, but the downside risk is limited by storage costs and interest. In reality, farmers would have to sell a lot of grain for this to happen, and I don’t expect that to happen considering current prices and the recent USDA news.

 

“Why should farmers collect on the carry?”

Collecting on the carry is very low risk. The market is very clearly paying farmers to do it. Waiting to sell from Dec to Sep is 10 months for 30 cents. The market is paying me three cents per month to wait to move my grain.

 

“What about interest on the grain?”

Yes, I need to consider this by deducting the expense from the carry profits. Assuming 5% interest rate, $3.25 corn cash value X 5% / 12 months = 1.3 cents per bushel per month to hold grain. In other words, the market pays me 1.7 cents per bushel per month to hold grain in my bin.

 

“Where does basis factor in?”

I will now watch basis levels for a rally. Currently, basis values for next summer are 15 cents better than today and 10 cents better than the best bid I saw at the beginning of harvest. Adding this premium to carry, and I will collect 25 to 30 cents of profit just for waiting to move my grain. I have not yet locked in my basis hoping that there is more upside in the basis. This is risk that I must manage going forward.

 

“Why doesn’t everyone do this?”

One, it requires on-farm storage (I recommend getting to 100% capacity) which many farmers aren’t willing to do. Two, it requires that you have your grain priced by harvest, again not something most farmers are willing to do. Granted much of this premium will go to pay my grain payment this year. However, my bin loan was only for seven years (this is year six of ownership for me). After next year, all of this profit will go in my pocket every year. An additional benefit to 100% storage is the drying/shrink savings and avoidance of long lines.

“That sounds great, but it sounds a little complicated. I prefer to just store my grain unpriced and wait for rallies. I’ve done ok in the past.”

This is a common phrase I hear from farmers. However, farmers need to remember that they will always need to sell another crop in 11 months. All farmers are hoping we get back to $4 or even $4.50 (me too). Even with my strategy if prices get above $4, I still get to take advantage of those prices. I’ll just be selling for 2017 instead. Then I STILL get to take advantage of carry/basis premium (25 to 30 cents) next year PLUS I get the benefit of the increased prices (if they were to happen). It’s a win-win-win for little to no additional risk.

 

“But I need money for cash flow…”

Most farmers are surprised when I tell them that if they explain their plan to their banker that their banker will likely be on board with this kind of plan. Cash flow is never a reason to sell grain if you have a plan that reduces risk and provides opportunity.

But in order to take advantage of these opportunities you need to do two things right now:

  • Build storage — plan to get to at least 100% storage on your farm by next year.

• Create a marketing strategy that includes not just futures price, but carry and basis too.

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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