Higher Prices-Sooner, Later or History?

March and early April have produced the fourth highest soybean prices ever and the highest corn prices since the record highs of 1996. Strong demand and tight supplies contributed to the price uptrends and recent USDA reports added bullish news. USDA's March 31 Prospective Plantings Report indicated reduced wheat acreage and less-than-expected corn acres. The April 8 Supply and Demand Reports suggest corn, wheat and soybean supplies continue to shrink. Prices have slipped from the highs, but remain at historically high levels.

Will prices rebound and go higher? If so, when? Some analysts believe the uptrends will continue with even higher prices to occur in the weeks ahead. Others expect "market corrections" with lower prices near term, but anticipate summer weather concerns will produce higher summer time price peaks. Finally, some analysts point out that the price highs may already be in the markets. There are valid arguments to support each of these opinions. Briefly, some of points for each position are as follows.

Higher prices soon: The South American soybean crop continues to shrink in size. USDA lowered their estimates for Brazil from 59.5 million metric tons (mmt) to 56.0 mmt and Argentina from 36.5 mmt to 35.0 mmt. However, many believe the final numbers may be much lower. While predictions of about 52 mmt have been common, some predictions of less than 50 mmt have been suggested for Brazil. Argentine soybean production estimates have been 33 mmt or less.

U.S. soybean exports appear to be coming in line with USDA projections, but domestic use price rationing is still needed. While USDA lowered expected soybean ending stocks to 115 million bushels, crush must be reduced significantly to meet these projections.

Corn demand remains strong with increases in projected industrial uses. Corn export demand is strong, due to decreased Chinese competition, and export projections may have to be increased. Ending corn stocks are estimated at 856 million bushels and may decline further if feed and export uses are higher than projected. New crop corn acreage is less than expected and higher prices are needed to "bid for corn acres" to insure enough is produced in 2004.

Higher prices later this summer: New crop U.S. soybean export sales are already strong. World demand will "use up" the shortened South American crop more quickly, resulting in less competition for U.S. production in early fall. This, along with very tight domestic supplies and crush demand, will keep summer prices high.

Increasing demand and less-than-expected corn acreage projections suggest corn supplies may grow tighter this summer and into next year.

Large 2004 production of both corn and soybeans will be needed to meet domestic and world wide demand. The markets will be uneasy until production is assured and, even with good weather, supplies may continue to shrink?resulting in higher prices. Poor weather could produce much higher prices!

Prices have already peaked: Even if the lowest South American production estimates prove correct, the world won't run out of soybeans. The South American crop will more than meet current world demand needs.

Domestic soybean demand is being rationed at these prices, processors have supplies on hand to crush and it just takes time for a slow down in use to become apparent. Meal and oil imports will also make up for some of the needed reduction in crush. Technical (chart) price patterns suggest a "double top" and "key" market reversals have occurred, reliable signals that a "high" may have occurred in the market.

Favorable planting weather and new crop prices suggest corn acres may be more than USDA projects. Increased feed costs will slow placements and feed use by livestock producers. Additionally, increasing export competition is occurring from other corn producing countries and increased world wheat production would provide feed use competition.

Good weather has the potential to produce a record corn crop with trend line or better yields and increased acres. Good weather would also result in soybean production that could lead to increasing ending stocks and lower prices.

This wide range of predictions suggests market volatility and uncertainty may continue for some time. Whichever high price outlook group (sooner, later or history) they are in, most analysts agree that these grain prices are not likely to "crash" soon and should be supported until 2004 production is better known. Currently, prices have slipped from the highs and may decline further but they still provide historically good pricing opportunities. Continuing to spread sales should capture profitable prices whether the highs are still to come or have already occurred.

Selling Strategies

Spreading sales, using price targets, trap (stop) prices or other pricing decision methods can aid in deciding when or at what prices to make sales. However, as more sales are made at higher prices, how to sell becomes increasingly difficult as production risks play an increasing role in decision making.

Cash contract sales are a simple and relatively low risk method of beginning to make new crop sales. Once a producer has contracted a portion of expected production for cash delivery, production risk or not being able to meet specified quantity delivery requirements increases the risks for cash contracts. At this point, instead of passing up selling opportunities, other sales methods should be considered.

Hedging with futures eliminates the risk of cash delivery requirements since futures contracts can be offset or settled without delivery of the commodity. Some losses would occur, but a futures hedge can also be liquidated if market factors change significantly providing additional marketing flexibility. The primary concern most producers have with using futures is the margin requirements. Cash outflow can be significant in volatile markets, especially for soybean hedges, and should be understood. Production risk isn't eliminated. However, as long as it appears the producer will have adequate production to offset the futures contract, margin requirements will be offset by gains in the cash market. If arrangements are made to meet margin requirements, futures hedges are effective for price risk management and have some advantages over cash contracts.

Buying put options replaces the risk of futures margin requirements with the known cash cost in the form of the option premium. Purchase of a put option carries no obligation to deliver the commodity or exercise the option to sell futures (enter a hedge). This allows capturing higher prices if prices continue to move higher, while still protecting a price floor-another advantage over using futures hedges. The problem with buying puts in volatile markets is the high premium costs. For example, on Wednesday (4-14-04) December '04 corn closed at $3.19 and the $3.20 (strike price) December corn put option premium was about $0.32. This would establish a futures price floor of approximately $2.88 ($3.20 strike price minus $0.32 premium)-historically a relatively good harvest time futures price, but significantly below the $3.19 futures price. In this case, the strategy is effective in managing price and delivery risks but it is expensive.

More complex or combination option strategies are being recommended by some market advisors. A "bear put" spread (buying an at-the-money put option and selling an out-of-the-money put option) in effect reduces net premium cost, but only provides a range of price protection between the two put strike prices. A "fence" (buying a put option and selling a call option) is a strategy to establish a price floor with the purchase of the put option. Selling the call option offsets the put premium, but creates an obligation to sell futures at the call strike price. If the call is exercised, the producer would then have a futures hedge at call strike price (not necessarily a bad sale) and an obligation to margin the futures position. These are only a couple of examples. These and other complex strategies offer risk management opportunities, but it is very important to understand how they work and any risks that may be associated with them.

The bull markets in grains and oilseeds are providing the potential for more pricing opportunities in the coming weeks and months. It is important to have a variety of marketing strategies in place in order to continue taking advantage of these opportunities. This may require selling strategies that not only manage price risk, but account for some of the production risks as well.