December 2001

Archived Issues

USDA Report and Storage Decisions

USDA's December 11, 2001 Supply and Demand Report didn't include any surprises. The corn supply and demand numbers were left unchanged for the November report. Soybean crush and export expectations were increased without any changes in supply estimates; the result was a small (25 million bushels) decrease in expected ending stocks. Wheat food and export projections were reduced for a combined 35 million bushels, which was reflected in a corresponding increase in ending stocks. What do these minor supply and demand changes, along with other market signals, suggest for stored corn and soybeans?

The corn crop is large (4th largest ever), but USDA is projecting record demand that will reduce corn stocks by the end of the marketing year. Normally this situation would be leading toward higher prices. Prices haven't rallied partly because several have questioned whether demand would be as strong as USDA projects- especially with slow export progress. In addition, while ending stocks will decline, supplies are adequate and current estimates are somewhat larger than earlier expectations.

At harvest time, market carry (premiums for March and May 2002 corn futures contracts over December contracts) and the potential for basis recovery along with tighter supply projections suggested storing corn. Basis (cash price discount from nearby futures contract) has improved in most locations since harvest. March and May futures contracts continue to offer storage premiums. It appears that hedging with March/May futures contracts or making early year (2002) cash sales would capture most of the storage gain the corn market has offered. Significantly higher corn prices will depend upon price rallies in the futures market.

The soybean supply and demand projections are all records-record production, record supply, record domestic use and record exports! Record production and supply along with a large South America crop has overshadowed record demand. Most analysts expect prices to remain depressed. In addition, stronger basis than in recent years and lack of market carry has not suggested any return to storage for soybeans. About the only reason for storing soybeans has been to mange cash basis income for tax purposes and that reason expires at year-end.

Supply driven markets are keeping grain prices under pressure. Despite a projected decline in ending stocks, corn supplies are still more than adequate. Record soybean supply and another big Southern Hemisphere crop should provide the world with enough soybeans. Strong demand and the potential for tighter corn supplies may eventually help rally prices-especially with planting or growing concerns next spring or summer. However, storing corn and/or soybeans for several months incurs storage costs and assumes considerable cash and futures price risk. Selling cash grain and buying futures or call options, to re-own corn and soybeans, might be a better strategy to capture potential rallies along with managing price and storage risks. Note: The Internal Revenue Service (IRS) misunderstands this risk management strategy and considers it to be speculation. Gains or losses from re-owning grain with futures or options are subject to capital gain limits-- not operating loss or gain for tax purposes.

The marketing loan or LDP (loan deficiency payment) provides price support at the county loan price. When soybean prices are below loan price, the risks associated with pre-harvest sales limit the incentives to lock-in prices. However, with strong soybean demand, weather or other production problems could produce volatile prices during next spring or summer's growing season. This situation also creates a difficult marketing environment. Do you sell early as prices move above loan price and risk missing much higher prices if the rally continues? If you delay sales, the rally may falter. Prices could drop sharply before you can react and you might miss the opportunity completely-leaving you again with only loan price!

One way to gain market flexibility and mange price risk in volatile or uncertain markets is to offset pre-harvest sales with call options. Buying the call option provides the right to re-own grain if prices continue to rise, but has no obligation if prices fall. Owning the call option provides "insurance" for making pre-harvest sales. It allows you the confidence to hedge or cash contract for fall delivery at a favorable price. If prices continue to rally, the call option allows you to capture the higher price by exercising or offsetting the call option. The gain from the call option transactions would be added to your locked-in cash sale price or your hedged price, resulting in a higher net price. If prices fall, you are protected against lower prices by the contracted sales price or hedged price.

Buying the call option early, when futures prices are near their winter lows, may reduce your option premium (cost of the option). You then own the call option and, if prices rally, are ready to make pre-harvest sales at favorable prices. If prices continue to rally, your "insurance" (the call option) is already in place at a lower premium cost.

Purchasing the $5.60 call option at $0.10 would lower your price floor to roughly $5.10 ($5.20 loan price minus $0.10 option premium). However, if weather problems cause prices to rally sharply (next spring or summer) to near $5.60 you could place yourself in a "win-win" position. You could begin to hedge soybeans with futures or forward cash contract at prices near (or somewhat above) the net county loan price of $5.10. If the rally continues, gains on the $5.60 call option would offset much of what you gave up by hedging or cash contracting. Your net price would be $5.10 plus the amount of gain from the call option. If the rally stalls and prices fall-you still have soybeans hedged (or sold) at the net price of $5.10. However, in the case of lower prices, the LDP also would add to your net price as cash prices fall and your net price would be above $5.10 by the amount of LDP. If November futures prices go above $5.60-you win (option gain plus hedge or contract price). If they go below $5.60-you win (LDP plus hedge or contract price).

This market strategy offers flexibility to deal with uncertain markets and minimizes price risk. The strategy requires a weather market scare that causes soybean prices to rally sharply during the growing season. However, it minimizes price risk and eases decision- making whether the rally does or does not occur. If November futures prices never approach $5.60, where you could forward price, you are only out the $0.10 option premium and still have the market protection provided by the market loan or LDP. A similar strategy could be used price corn.