Post Harvest Market Strategies

USDA's November 9, 2001 Supply and Demand Report, while not a shocker like the October report, contained more negative supply news for 2001-02 crops. Corn production estimates were increased about 1% from the previous month and is the fourth largest production on record. The record soybean crop continues to get larger at almost 3 billion bushels (2.92 bill. bu.). Besides negative production news, USDA made no changes to estimated corn demand and only minor changes to expected domestic soybean use. Ending corn stocks are expected to be 1.574 billion bushels at the end of the marketing year-up from 1.453 billion estimated in October. Soybean carry over is now estimated at 355 million bushels, up from 345 million bushels last month.

Markets rally on bad news-a positive sign? Despite the negative production news and lack of expectations for increased demand, corn futures closed up three cents or more and soybeans were nearly seven cents higher the afternoon following the report. This is a positive market signal and appears to suggest that the fall lows are in!

While the November Supply and Demand Report was generally negative, not all market news is bad. In spite of increases from the October report, both U.S. and World corn ending stocks are expected to decrease in the year ahead. Large livestock numbers could add to corn use and some analysts believe there is potential for more export demand. The strong export pace for soybeans makes a good case that export demand is underestimated and a high soybean crush margin suggests soybean product demand.

Does the current supply and demand news suggest any market strategy changes for corn and soybeans that are now in storage?

Corn prices remain in the lower one-half of USDA's projected farm price range ($1.80-$2.20), suggesting higher prices will have to occur to meet the expected $2.00 average price. March corn futures continue to offer about twelve cents of market carry (market premium for storage) over the December contract. Higher price expectations and market carry, along with seasonal basis recovery, signals the potential returns for storing corn into winter or early spring-possibly longer.

Market signals for soybeans are not as clear. Soybean prices, like corn, are generally in the lower one-half of USDA's expected price range and appear to suggest somewhat higher prices. Basis also would be expected to strengthen following harvest. However, March soybean futures only offer four to seven cents of market carry. This small carry, even with potential basis strengthening, doesn't appear to offer much of a return to storage. In addition, price increases may be hard to come by if the South American crop doesn't run into problems and provides export competition by spring. With the lack of storage incentives, capturing a post-harvest price bounce appears to be a better strategy than holding soybeans in storage for any length of time.

What about storing for higher prices? Long-term seasonal trends would suggest higher prices into spring for both corn and soybeans, but competition from South America has made this price pattern unreliable in recent years for soybeans. Stronger than expected domestic and/or export demand along with production problems in South America offer possibilities for higher prices. While better prices are possible, storing grain expecting (or hoping for) higher prices is a speculative strategy with sizeable risk. To deal with this risk, marketing strategies should manage risk and be flexible. Capturing a post-harvest price bounce for stored soybeans and then re-owning with futures or call options is a less risky strategy to speculate on higher prices. For corn, the market appears to be offering storage returns (market carry and basis gain) along with some higher price potential. However, once storage returns can be captured, a similar strategy to sell cash grain and re-own on paper should probably be considered for corn too.

Soybean Crush Margin

The soybean crush margin represents the value added by crushing soybeans into meal and oil. This margin can be calculated using local cash prices to determine the margin for an individual plant or can be calculated using Chicago Board of Trade futures prices ("board margin").

The crush margin is calculated by the sum of the price per pound of meal and oil times their respective prices minus the soybean price per bushels. A bushel of soybeans typically yields 44-48 pounds of meal and 10-11 pounds of oil. Crush Margin = (meal price [ton] / 2000 x 48) + (oil price [lb] x 11) - Soybean price [bu]. For example, on Wednesday (November 14, 2001) January futures contract prices were: soybeans $4.47, meal $158.80 and oil $0.1627. The crush margin was $1.13 ([$158.80/2000 x 48] + [$0.1627 x 1] - $4.47).

The soybean crush market can serve as a signal for soybean and soybean product demand. A strong (large or wide) crush margin indicates profitability for soybean processors and is a positive demand signal for soybeans as processors respond to a strong margin by increasing crush. Current crush margins (above $1.00 per bushel) are strong and have been at these levels less than 5% of the time during the past ten years! These profitable margins suggest that processors may be willing to bid more for soybeans as harvest pressure eases.

Strong crush margins and exports, which are running ahead of last year, are positive demand signals for soybean use. Soybean use is responding to several years of large or record production in both hemispheres and low prices. Large production and supplies are likely to keep a "lid" on prices, but positive demand signals are encouraging and suggest the need to keep longer-term production and marketing strategies flexible.

When a Hedge is Not a Hedge!

A recent agribusiness company's producer magazine carried an article recommending a "cross-hedge" for corn producers. The strategy was to use wheat futures to hedge corn. The writer suggested wheat/corn price spreads along with deferred futures prices offered a chance to net a better hedge price for corn. While the strategy sounds attractive, it is important to understand that this is not a true hedge!

Cross hedging is hedging one commodity using the futures market for another commodity. Cross hedging is based upon expectations that the prices of both commodities move in similar patterns and react similarly to market news. If the prices of the two commodities move together, one theoretically can be used to hedge the other. Using corn futures to hedge grain sorghum is a common example of cross hedging. The expectations are that, since both are feed grains, the price pattern for grain sorghum will be the same as corn.

The problem with cross hedging is that it is not a true hedge. For example, some market factors may affect corn prices more than they affect grain sorghum prices-causing the prices to react differently. This could produce gains or losses in corn price that are not offset by changes in grain sorghum price and fail to meet the hedge objective of locking in a grain sorghum price. While termed a "hedge," a cross hedge actually includes "speculation" that prices will move the same.

The wheat/corn cross hedge strategy carries this speculative risk. Different market factors affect the corn and wheat markets. While both can be used as feed, they have other uses and competition that are quite different, which may cause their prices to move in different directions. In addition, the strategy also plans on changes in the wheat/corn spread to enhance hedging gains-this is speculation on a price spread! Spread trading is usually considered less risky than price speculation, but both are speculation and involve risk. When complex market strategies are offered, it is essential to understand them thoroughly and recognize all risks they may contain.

The wheat/corn strategy may work, it depends upon the price spread and if wheat and corn prices follow similar patterns. However, it is important to understand that it is really not a hedge, it is speculation to enhance net corn price. If the goal is to protect corn price and reduce risk-use the appropriate corn futures contract for hedging!