Mid-October corn and soybean prices were significantly lower than pre-harvest price highs in early September. Anticipation of a price recovery and managing cash income for "cash basis" income tax calculations provided many producers with reasons to store corn and soybeans. However, the decision to store tended to ignore or overlook important market signals.
Futures market carry and cash market basis provide signals for making grain storage decisions. The price premium offered by distant month futures contracts, or market carry, represents the return the futures market is offering to pay for storage until the delivery month. Basis (the price spread between cash and futures price) is how the cash market encourages or discourages cash grain movement (see table, Using Basis as a Market Signal for Grain Storage Decisions). A weak basis (wide spread between cash and futures price) is a signal to delay sales and store grain. Strong (narrow) basis signals the market is bidding for grain and discourages storage. While basis contracts can lock in basis and futures spreads may capture market carry, most producers attempt to capture basis and market carry by storing cash grain.
| Basis is: | ||
| Expect futures prices to: | Weak (Expected to Strengthen) | Strong (Risk that basis might weaken) |
| Increase | Store Cash Grain | Sell Cash Grain & Re-own with Futures or Re-own with Call Options |
| Decrease | Store Cash Grain & Hedge with Futures or Purchase Put Options | Sell Cash Grain |
While there were solid fundamental and technical arguments for higher prices, harvest-time markets were not signaling storage returns. During the peak of harvest, the March corn futures contracts offered premiums (carry) of about five to seven-cents over the December contract and January soybeans had a carries of less than one to five-cents over the November contract-not enough to recover storage costs! May and July contracts for corn and soybean offered little carry and , on occasion, soybean contracts were inverted (distant months discounted to nearby) signaling a penalty for storage. Additionally, corn and soybean harvest-time basis levels remained stronger than in recent years and limited the amount of basis gain expected to be captured with cash grain storage. The combination of small market carry and limited basis gain potential signaled that the markets were not offering storage returns. Other than tax management, the only reason to store grain was higher prices that were anticipated to occur in the futures markets.
Once tax management objectives are accomplished, grain storage decisions need to be reviewed! While there may continue to be good reasons for expecting higher prices, storing cash grain may not be the best way to capture these price gains. Continued limited basis gain potential and narrow market carry will not provide sufficient returns for storing cash grain. Instead, spring and summer storage profits will likely be dependent on higher prices in the futures market. Capturing higher prices might be better accomplished by selling cash grain and re-owning it with futures contracts or call options (paper storage).
Re-owning grain by purchasing futures contracts: Storing cash grain or buying futures contracts speculates on gains from higher futures prices. Both strategies carry the risk of losses that occur with lower futures prices. However, storing cash grain carries additional risks that the futures position does not. Should basis weaken, storage price losses might be greater than futures losses with a price decline. Storage costs will continue to add up as long as grain remains in storage and on-farm storage also carries the risk of grain going out of condition or possible theft losses. The common concern with a "paper storage" strategy is margin deposit requirements on the futures position and the need for additional money if prices move against the position. It is important to be prepared for this and understand that margin losses on a futures position is not that much different than a value loss on grain in storage- it's just more obvious and worrisome when cash is required to cover losses on a futures position!
Re-owning grain by purchasing call options: Selling cash grain and purchasing a call option offers similar advantages to re-owning with futures. The advantage to purchasing call options is that there are no margin requirements and any losses are limited to the amount of the option premium (cost). The disadvantage is the amount of the option premium, which the option seller (writer) keeps regardless of what happens to prices. However, option premiums may be comparable to storage costs, especially if several more months of storage are anticipated. Sometimes the cost of options may actually be less than the cost of storing, making an option strategy more attractive.
The key to market strategy decisions, at the beginning of the New Year, may be determined by what is happening to basis and market carry. Limited potential for basis gains and a continued lack of market carry would be signals to move cash grain and consider using the futures market for price speculation. Even if futures market carry increases or cash demand produces unusually strong basis next spring or summer, storing well grain into the New Year may not be worth the risk and cost. Speculation always includes price risk, but "paper storage' eliminates storage costs and other risks when the market is not offering storage returns.