Uncertainty and Market Risk Ahead?

Large grain supplies are expected. Using USDA’s prospective planting acreages and assuming trendline yields, new crop corn and soybean production will result in continued abundant domestic supplies. In spite of some production problems in Brazil, record South American production will raise current year world soybean ending stocks to record levels. World corn ending stocks, along with other coarse grains and wheat, are projected to increase. Based on these projections for large corn and soybean supplies, low prices in the months ahead appear likely. However, strong demand, production risks, and other factors have caused price volatility and uncertainty, resulting in unexpected price rallies and making marketing decisions difficult.

A number of production risks that may impact crop size have captured the attention of the markets. Increasing fuel and fertilizer prices have added significantly to the costs of production, especially for corn, and may impact actual planted acreages. Typically, crop diseases and insects only affect localized areas, but Asian soybean rust and soybean aphids add serious soybean production threats this year. While weather is always a worry, weather concerns may have significant price impact this year. This can be illustrated by the March price rallies fueled by dry weather in Brazil, in spite of the facts that their production was still expected to be a record and world supplies were growing to record levels. Now, although U.S. planting is off to a good start, some are expressing concerns that changing weather patterns with more rainfall could delay corn plantings. At the same time, others are concerned about dry conditions in Nebraska and other western states. While these concerns may be premature, it suggests that the markets will be sensitive to weather and other production concerns for some time, possibly resulting in wide price swings.

Outside factors also add to market volatility. The declining dollar value and strong demand for all commodities has contributed to price uptrends in most other commodities (energy, precious metals, tropical food, industrial commodities, etc.). Fund traders, with large amounts to invest, have been attracted to all commodities. However, some of the fund traders believe that grains are underpriced when compared with other commodities and have purchased large amounts of grain and oilseed futures contracts. This bullishness seems to ignore abundant domestic and world grain and oilseed supplies, suggesting the potential for volatile, unpredictable, or risky speculative market price actions. While these outside factors continue to support prices, the downside reactions could be rather sharp if other commodity price trends change or the dollar stops declining.

While considerable market risk exists, it is possible to manage some of these risks. For any remaining old crop (2004 production) corn and soybeans, the best advice may be to sell price rallies. However, since current soybean prices are above USDA’s projected price range, an additional strategy is to set "price traps" (downside price targets below current prices) to trigger sales if prices decline instead of increase. Having both upside and downside price targets can trigger soybean sales at favorable prices whichever direction prices move. Additional market factors need to be considered for new crop (2005) production sales and marketing strategies may differ for corn and soybeans.

Corn acreage is expected to increase 1% to 81.4 million acres. Although old crop corn demand has been strong, it has not lived up to previous expectations and projected ending stocks are expected to increase at 2.214 billion bushels, the highest levels since 198788! Assuming trendline yields, the increased acreage plus a large carryover suggest 200506 domestic corn supplies will be burdensome and continued low prices can be expected.

Seasonal trends point to lower corn prices. In eight of the past ten years, corn futures prices have been lower at harvest time (OctoberNovember) than they were in April. While this suggests lower prices in the fall, current new crop (December) corn futures prices are already near levels where the government program provisions provide price protection. Lower prices would likely trigger countercyclical payments (CCP) and loan deficiency payments (LDP), suggesting little need to hedge or forward contract at current prices.

Although the corn price outlook is pessimistic, more aggressive marketers might want to consider a "confidence" call option strategy in order to be better prepared to sell any price rallies that might occur during the growing season. This is accomplished by buying outofthemoney (OTM) call options when prices are low and the premiums relatively inexpensive. If prices rally, due to production concerns or other factors, owning the call option provides "confidence" to hedge or forward contract to capture price gains in uncertain market conditions. If prices continue to increase, gains on the call option will offset "missed" higher prices that occur after the hedge or contract sale was made.

Although expected soybean acreage of 73.9 million acres represents a 2% reduction from last year, it is higher than many had predicted earlier in the year. Additionally, the market appears to be "bidding for more soybean acres." Recently the new crop soybean/corn futures price ratio has been more than 2.6/1; a price ratio that favors soybeans over corn and signals the market may want more soybeans. It raises the question as to why the market wants more soybeans when domestic projected ending stocks are burdensome and world supplies are at record levels! While it may represent market concerns about soybean rust, this is somewhat surprising and may suggest a marketing opportunity for new crop sales.

The seasonal price trend for soybeans also is usually lower as the growing season progresses. In six of the last ten years, new crop soybean prices offered in late April or early May were higher than prices offered during October. Current November soybean futures prices, while considerably off the March highs, may still be offering pricing opportunities with prices well above most projections for 2005/06 soybean prices. This suggests strategies for spreading sales, particularly for soybeans that must be delivered at harvest time, on price rallies into mid May. It also might be a good idea to set price traps or downside targets to make sales if prices begin to decline below chart support levels.

Soybean put option premiums are expensive, making them less attractive as a marketing strategy. However, they may still offer opportunities to protect prices that are above CCC loan prices and the net price could look much better next fall if soybean prices decline as low as many predict. For those more comfortable using options and understand how the strategy works, using an option fence (buying a put option and selling an OTM call option) may offer pricing opportunities. This strategy can protect a price range and collecting the premium from selling the call option lowers the net cost of the strategy.

Uncertainty and the potential for volatile markets appear likely to create significant market risk in the months ahead. Growing season weather conditions, whether rust spreads and impacts soybean production, Chinese soybean demand and corn export competition, the value of the dollar, fund trading money flow into commodity markets, and other unexpected events will impact grain prices. Market volatility also may impact how sales are made. Wide price swings increase the amount of account margin funds that may be needed for futures hedges. Volatility increases option premiums, making these strategies more expensive. Current posted new crop cash bids at selected Missouri locations reflect a fairly "normal" harvest time basis. Rapid futures price up moves are not always totally reflected in cash market bids, as basis often weakens during sharp price moves in uncertain market conditions.

It is important to remember that the primary objective is to manage risks, capture above average prices, and try to avoid selling near market price lows (which often occur at harvest time), not chasing the nearly impossible task of selling at the highest price. This is best accomplished by spreading sales with a marketing plan that targets reasonable objectives and allows the flexibility to change as market outlook changes or unexpected market opportunities occur.