Surging Demand, Tighter Supplies, Higher Prices. . . Maybe or Maybe Not?

USDA’s May 12, 2006 supply/demand projections point to higher corn prices. Reduced corn acreage along with optimistic demand expectations for ethanol use and exports lead to predictions of a nearly 50% reduction in 2006-07 corn ending stocks (1.141 billion bushels) compared with the current year’s carryover (2.226 billion bushels). World coarse grain and corn supplies also are expected to decrease. These factors are expected to contribute to 2006-07 average corn prices ($2.25 to $2.65) that are 30 to 60 cents higher than for the 2005-06 crop ($1.95 to $2.05).

The futures market has responded to the corn supply/demand projections with higher prices. December 2006 corn futures have traded in excess of $2.80 per bushel since the USDA reports. In only 3 of the last 20 years have September nearby futures prices been equal to or higher than what is currently offered by December corn futures for harvest time delivery! $3.00 plus corn prices are even available for new crop production as July 2007 futures prices have traded for more than $3.00. Futures prices for 2007 and 2008 corn production also are trading for more than $3.00. During the last 20 years, nearby futures (at the time of delivery) have been above $3.00 only about 10% of the time. This would suggest that current futures prices are offering historically good prices for corn.

In contrast to corn, the soybean supply/demand projections appear negative. USDA expects record 2005-ending soybean stocks of 565 million bushels to swell to a carryover of 650 million bushels by the end of the 2006-07 marketing year. However, in spite of the record carryover levels and the highest projected stocks/use ratio in more than 20 years, soybean price projections are relatively stable with the midpoint of USDA’s projected 2006-07 price range of $5.60 is near the 2005-06 average price of $5.65. November 2006 soybean futures prices have been trading for more than $6.20 per bushel, a price achieved less than 50% of the time during the last 20 years, and in only 5 of the last 20 years have nearby futures prices been this high at harvest time (October)!

Lower expectations for 2006 wheat production and reduced ending stocks projections, from 532 million bushels (2005-06) to 447 million bushels (2006-07), provide bullish news for wheat prices. World wheat supplies also are expected to decline. As a result, USDA projects higher wheat prices in 2006-07, expected to range $3.50 to $4.10 compared with 2005-06's average price of $3.42. Although these should be considered favorable prices, July 2006 futures prices continue to move higher. Chicago July (SRW) wheat prices have traded for more than $4.20 per bushel and Kansas City (HRW) wheat prices have exceed $5.00!

USDA’s expectations for strong corn demand along with tighter supplies for corn and wheat are part of the reasons for grain price strength that appears to be spilling over into soybean prices. Drought concerns have lessened, for now, with rainfall in the Corn Belt, but dry weather could still produce market "fireworks." Higher prices also are supported by higher prices for other commodities (metals, energy, etc.), and a weaker dollar. Some analysts have suggested grain prices could be moving to a new higher price plateau, but others caution that supply/demand outlook may become less bullish. Good planting conditions could result in more corn acreage and a higher average yield, leading to more production than USDA is projecting. Demand projections may be overly optimistic and carryover corn supplies could end up considerably larger than currently predicted. Larger than expected new crop corn supplies, coupled with the record soybean carryovers and any liquidation of long positions by large index funds in the futures market, could lead to sharply lower futures prices.

Not all market pricing signals are positive. Although corn and wheat futures prices have continued to rally and soybean futures prices maintain support, market carry and weak cash basis suggest burdensome supplies or a lack of strength in nearby grain/oilseed demand.

The "carry" (distant month futures price premium) in new crop corn futures prices results in $3.00 plus prices for 2007 futures contracts, but the futures market carry also is a signal of weaker nearby demand. With the large 2005-06 ending stocks, current corn supplies are more than adequate. Buyers in the futures market are not exhibiting concern about supplies or bidding up prices for nearby contracts to meet current needs and are willing to let someone else own the grain. This suggests that higher corn prices for distant month futures are more a result of premiums for storage and production risk, along with speculation about supply demand balances in 2007 or later, rather than current supplies or demand strength.

Weak basis (wide negative spread between cash bids and futures price) is a market signal that suggests weak cash demand. Although transportation costs (due to higher fuel prices) probably impact basis somewhat, anticipation of plentiful supplies of corn and soybeans are producing weak old and new crop cash bids throughout Missouri. New crop corn bids in many locations are 40 cents or more under December futures prices, with some locations (particularly in northwest MO) at 50 cents to more than 60 cents under. New crop soybean cash bids also are disappointing, with some western and northwestern MO locations more than 60 cents under November soybean futures prices. However, due to the negative soybean supply/demand estimates, downside soybean price risk potentially more than offsets the weak basis and new crop cash bids may still offer a pre-harvest sales opportunity.

Weak basis does not necessarily mean that sellers are getting "ripped off," it is simply a market signal that buyers expect to get all of the commodity they need without having to bid prices up-cash supplies are expected to exceed demand!

Not only is the wide basis a worrisome market demand signal, it limits new crop marketing alternatives. New crop futures prices suggest considerable risk that lower prices are a possibility at harvest time. However, while new crop futures prices offer historically high prices, the weak basis results in disappointing new crop cash bids. It doesn’t appear to be much of a marketing opportunity for making preharvest sales when new crop cash bids are only in the lower half to middle of USDA’s projected 2006-07 average price range!

Another use of basis as a market signal is to help decide on how to make sales. A weak basis suggests avoiding cash sales, since the cash/futures price relationship usually doesn’t get much worse. Use the futures market to make sales in anticipation (hope) that basis will eventually improve before the commodity is delivered. Although basis may not improve anytime soon, disappointing new crop cash bids appear to be saying, "use the futures market!"

Selling futures contracts captures current futures prices and can offer marketing flexibility not available with forward cash contracts. However, the possibility of higher prices and cash flow risk of maintaining futures account margins may keep many producers from using futures. Option strategies limit some of the risks associated with using futures. Buying a put option is a relatively simple "price insurance" strategy, but option premiums (cost) also can result in disappointing net prices, especially if basis does not improve. More complex option strategies, such as a "fence" (buying a put and selling a call at a higher strike price) may offer more attractive prices, but it is important to understand the various risks associated with this and other strategies that involve selling (writing) options. In spite of the complexity of these strategies, in the current market situation filled with uncertainty and weak cash bids, they are likely to serve as better preharvest marketing tools than trying to use the cash markets.

USDA’s supply/demand projections for 2006-07 provided some surprising bullish news and futures markets have reacted with higher prices that normally would be very attractive. Will these higher prices last or go higher? Maybe. Maybe not. Current futures prices appear to be favorable prices that normally should be rewarded with sales because lower prices are certainly a possibility too. But weak basis signals cash market supply/demand weakness and produces lower cash price bids. The result is a complicated marketing outlook and a challenging environment for making selling decisions. If these selling strategies are limited to using only the cash market, prices are more likely to be disappointing.