Corn and Soybean Prices-How High?

The January 12, 2004 USDA Grain Stocks and Supply/Demand Reports provided bullish news for corn and soybean markets. The markets responded with sharply higher prices and renewed the enthusiasm for higher prices by market bulls. Many now believe $3 corn may be possible and $9 or higher soybean prices are within reach. This has produced a volatile market, capable of sharp price moves up or down. Are these prices expectations reasonable and what are the risks in trying to capture them?

Corn: the supply/demand balance is changing. Record crop production usually means increased supply and lower prices. Previous USDA supply/demand projections indicated this would occur with estimated '03-'04 ending corn stocks of 1.299 billion bushels exceeding '02-'03 ending stocks of 1.087 billion bushels in the December reports. The January USDA reports placed 2003 corn production at 10.114 billion bushels, which is a record. However, it is a reduction of 164 million bushels from estimates in December and USDA increased expected use 155 million bushels. These changes resulted in estimated '03-'04 ending stocks of less than one billion bushels (981 million)-a decrease instead of an increase over the previous year! With U.S. ending corn stocks falling below one billion bushels and world supplies already very tight, the outlook for corn prices becomes more bullish.

Although the USDA reports suggest higher prices, the markets are not suggesting storage returns. Futures market carry (price premiums for distant month futures), while somewhat improved following the reports, does not offer a return over storage costs. The potential for basis gain (price spread between cash and futures prices) is also limited and basis risk may be increasing. The risk for weaker basis was demonstrated as corn deliveries increased in response to higher prices following the reports. This resulted in lower cash bid gains compared to futures price increases. Limited market carry and lack of basis gain potential suggest that returns for storing corn will have to come from higher futures prices. This means storing cash corn is speculating in the futures market! This is not necessarily a bad strategy, but it does suggest taking a look at alternative strategies.

An alternative to storage for capturing higher prices is to sell the corn and re-own it with call options. This strategy eliminates basis and downside price risks. However, option premiums are somewhat expensive. July at-the-money call option premiums may be competitive with commercial storage costs, but exceed the cost of on-farm storage. Using a bull call spread (buying at-the-money calls and selling out-of-the-money calls) lowers premium costs. This can be an effective strategy to reduce risk and capture limited price gains. The disadvantage may be the price ceiling created at the short (sold) call strike price. It is important to understand the mechanics of these strategies and weigh the advantages/disadvantages against market risks of speculating with stored grain.

Soybeans: a high-risk market. U.S. soybeans remain in short supply. USDA lowered an already short crop production even more in the January 12 reports. While export projections were increased slightly, domestic use was reduced and projected ending stocks remained the same as the previous estimate of only 125 million bushels. The concern is that, while USDA projects a decline in use, soybean use has increased the first three months of the marketing year. Rationing has apparently not occurred, although some export sales have been postponed, and reduced use must happen during the remainder of the marketing year. Many analysts have argued that higher prices were needed to ration short U.S. supplies and, in response to the apparent lack of rationing, futures prices exceeded earlier highs by moving sharply higher following the reports.

While prices appear to be headed higher, recognize that the soybean market is volatile and uncertain. U.S. soybean supplies are tight, but the world supply situation should be more than adequate. Domestic users may need to scramble for remaining U.S. supplies, but export markets will soon look to South America for soybeans. In spite of some weather and rust concerns, South American soybean production appears to be headed toward another record high and, if they can move it quickly to export markets, will be available to meet world needs by early spring. Large South American production is necessary to meet demand needs and the risk of weather or rust problems may keep volatility in the markets for a while. However, large South American soybean production can be expected to eventually weigh on the market prices.

Market carry and basis in the soybean market are not offering signals for storage returns. Although distant month futures prices have gained on nearby months, market carry remains negative for July contracts. Similar to corn, soybean basis has been strong and weakened during the futures price advance following the USDA reports. It is possible that a much stronger basis could occur next summer as domestic users scramble for tight U.S. supplies, although these gains may not offset the potential for lower futures prices following the South American harvest.

Storing soybeans is a high-risk activity. Accepting high risks can offer big rewards and it can also be very costly. It is probably not a market for the "faint hearted" or those unable to bear the risk. Continuing to store soybeans may allow capturing higher prices that may be needed to ration short supplies, but price volatility may make it difficult to decide when to make sales and the risks associated with waiting too long to make sales are great. A variety of sales methods may be needed, such as: scale-up or spreading of sales; using price traps or trailing stops; and following the markets daily in order to react quickly. Options might offer alternatives, but volatile markets make option premiums expensive. At-the-money put option premiums are near fifty cents per bushel. While this cost may seem excessive, these options may make it possible to protect historically favorable prices. The same is true for using call options to re-own soybeans. Call option premiums (even for out-of-the-money options) are expensive. In spite of the cost, they may be useful in a volatile market capable of big price moves during a single trading session by offering a lower risk opportunity to capture some price gain.

New Crop Marketing Plans

With old crop corn ending stocks now projected below one billion bushels and ending soybean stocks estimated at only 125 million bushels, the markets may begin to focus on needs for large new crop production. While the need is there, it is important to recognize that large production may eventually result in lower prices-especially for soybeans that are not expected to be in short supply worldwide. While weather or production risk may impact the markets later, this early season focus on supply may offer profitable pricing opportunities as the markets "bid for acres" of corn and soybeans in 2004.

New crop pricing goals should be set based on profitable prices and plans made for selling strategies to capture these prices. At this point, a variety of strategies (setting price targets or goals, spreading sales, scale-up selling, etc.) can be used with a variety of marketing tools (forward or cash delivery contracts, minimum price contracts, futures hedges, put options, etc.). Combinations of these strategies and tools can also be used to help manage weather and production risks that may occur as the season progresses. It is also important to identify "price traps" or downside price goals to make sales if market trends reverse and before prices decline too far. Setting these price traps just below technical support price levels can help avoid the risk of waiting too long to make sales in a volatile market. In an uptrending market, using a series of successively higher trap prices or "trailing stops" as prices move higher can be used to follow a trend and make sales when prices reverse.

New crop (Dec '04) corn futures prices gapped sharply higher, above previous price resistance near $2.55, following the January 12 USDA reports. By the week's end, December corn prices moved above $2.70. This price action, along with the seasonal trend of new crop corn prices to move higher from January into the March/April period, suggests potential opportunities for early pre-harvest sales.

New crop (Nov '04) soybean futures prices also moved sharply higher following the USDA reports, ending the week at profitable price levels near $6.70. In recent years, the new crop seasonal price trend has been declining prices from January into early summer due to the impact of South American production. While volatile markets and tight U.S. supplies may push new crop soybean prices higher, recent seasonal trends suggest being prepared to capture some of these potentially profitable prices soon.

New crop (July '04) wheat prices have become more volatile, but remain in an uptrend. The January 12 USDA Winter Wheat Seedings Report estimated all winter wheat (hard red, soft red, and white) seedings down from last year and well under trade expectation for an increase in acreage. This added bullish news to a market already containing concerns about production in drought areas. Market news such as this often offers pricing opportunities for pre-harvest sales. Market price response to the USDA report was positive, but not as dramatic as corn and soybean price action. While prices have been moving up, remember that the seasonal trend is usually down at this time of year.