Soybeans: Short Crop = Volatile Market

USDA's November Supply and Demand Reports now estimate 2003-04 soybean ending stocks of only 125 million bushels, a number considered by many analysts as a bare minimum "pipeline" level of supply. However, use may be underestimated because domestic crush and exports are continuing at a rate that would exceed USDA's demand estimates. Several market analysts have pointed out that these rates of use cannot continue because it means running out of soybeans, suggesting higher prices are needed to further ration limited supply.

Soybean prices have responded to supply/demand factors by trending sharply higher throughout harvest. January futures peaked near $8.03 on October 29th. Since then prices have retreated but remain in an uptrend. Prices also have been volatile with price movements (up and down) of more than twenty-cents per bushel occurring on several occasions. Has the soybean market already peaked near $8.00 or will it go higher?

Not all market news is price positive. While U.S. supplies are tight, World soybean supplies are expected to remain large. Record South American production is expected totaling almost 1.5 times the 2003 U.S. soybean production! It seems likely that prices may decline rapidly as the potential for record South American production becomes a reality. These supplies will be available to meet World demand by early spring and has been reflected in lower prices for distant month futures, producing lower price offers for next spring and summer. The markets will also watch closely for slowing of use and prices may decline sharply if this becomes evident. While many analysts continue to stress the need for higher prices to curtail use before the South American harvest is available, market volatility and the inability of price to move back to or above $8.00 in early November is worrisome. It suggests considerable price risk from a market that could change direction quickly.

Soybean market volatility was illustrated by market action on Wednesday (11-19-03). Uncertainty over the cancellation of a visit by a Chinese trade delegation contributed to a twenty-eight cent decline in January soybean futures price. Worries that canceling this visit might signal cancellations or cut backs of Chinese soybean purchases produced the market collapse and nearly broke the price uptrend.

Market signals do not encourage storing soybeans. Basis is narrower (stronger) than recent year averages. While some believe much stronger basis will be necessary to encourage cash movement of soybeans, current basis levels signal good cash demand and limited potential for cash market gains. Limited basis gain potential and the negative market carry (discounted distant month futures prices) are market signals that suggest possible storage losses or a "penalty" for soybean storage into late winter.

Without positive market storage signals, holding soybeans is speculating on higher prices and carries considerable price risk in a volatile market. Current prices represent favorable prices and are near the upper end of USDA's projected price range. Capturing the "market high" price is a nearly impossible goal; so spreading sales during the current period of favorable prices is a more realistic approach. This can be accomplished by selling equal or increasing amounts as prices move higher. This can be done with regularly spaced sales over time or making sales as prices reach upside price targets.

This is also a situation that demands having down side "price traps." Price traps are downside objectives representing "bail out" prices that are sold, as the market turns downward. The objective of these price traps is to sell quickly to capture or "trap" relatively good prices before the market declines further.

What about using options to manage risk? Option premiums (cost) are expensive in volatile markets, but put options may offer an opportunity to establish a "price floor." For example, the March '04 soybean contract closed at $7.54 ¾ on Thursday (11-20-03). The premium for a $7.60 (strike price) March put option was about $0.43. While this premium seems expensive, it is important to recognize that in a volatile market price movement often exceeds this amount in a short period of time. Assuming a basis of minus fifteen to twenty-cents, buying the put would protect a floor price of near $7.00 ($7.60 strike price, minus the $0.43 premium and basis of -$0.20 to -$0.15 = $6.97 to $7.02). This would protect downside price risk while speculating on a return to $8 or higher prices with stored soybeans. Other more complex option strategies might also be used to protect or speculate on prices.

Whatever the marketing strategy, if storing soybeans, it is important to have a plan and be prepared to move quickly in volatile markets. Prices may go higher, but relatively large World supplies and the prospects of record South American production means current price levels probably won't last! Remember that these markets often peak when the news is bullish and everyone is expecting them to go higher.

Corn: Record Crop and Record Use

While the estimated production increase was less than many expected, USDA's November Reports increased the size of the 2003 corn crop to a record setting 10.278 billion bushels. Use is also expected to be a record (10.025 billion bushels) due, in a large part, to continued growth in corn used for ethanol and increased export projections. In spite of the expected strong demand, carryover supplies are projected to increase to 1.349 billion bushels compared to last year's 1.086 billion bushels. A large crop and increasing carryover supplies usually results in lower prices. USDA recognizes this and estimates prices to range $1.90 to $2.30 with an average of $2.10 per bushel.

The World corn supply and demand situation is much different than the U.S. situation. World ending stocks are declining from more than 5-billion bushels in '01-'02 to an estimated 2.9-billion bushels at the end of '03-'04. This creates an interesting market situation. Will large U.S. supplies pressure prices or will tight World supplies increase export demand and send prices higher?

USDA already projects less competition from China and Argentina (the two largest exporters after the U.S.). In 2002-03 China exported about 600 million bushels and Argentina more than 470 million for a total of more than 1.070 billion bushels. In the coming year, Chinese exports are expected to drop nearly one-half to about 334 million bushels and Argentina's export projections are trimmed to approximately 394 million bushels. These projections total about 728 million bushels-a drop of more than 340 million bushels from last year. USDA's November estimates already show U.S. exports increasing by 283 million bushels. The big question is: what will China really do? Will they decrease exports this much? Some think there is a possibility of even greater cuts and that China might even import some corn! This suggests the potential for stronger U.S. corn exports, which would reduce U.S. carryover and result in the possibility of higher prices.

Corn prices are beginning to reflect some of the market uncertainty. Prices in most Missouri locations have already been in the upper one-half or exceeded USDA's projected price range in recent weeks. Are these prices that should be captured or does the potential for higher prices justify storing corn into the New Year?

Distant month futures are offering limited market carry or a premium for storage until the distant month for delivery of corn. March '04 corn futures offer a premium of almost 6-cents and May offers 9-cents over the December '03 contract (11-20-03). Basis is narrower or stronger than recent years, but still suggests some potential to capture limited basis gains. While the futures market is not offering "full carry" (full cost of storage), the carry plus the potential for some basis gains suggests a limited potential to recover storage costs on farm-stored corn. However, significant storage returns appear to depend upon the possibility that tight world supplies and strong demand will result in higher prices.

An alternative to storing would be to sell the cash corn and re-own it on paper with either futures or call options. For example, the cost (interest + storage costs) of storing corn in on-farm storage until late April is about $0.10. Suppose the corn is sold and replaced with a $2.40 March call option at a premium (cost) of about $0.12 (11-20-03). The option premium is slightly higher than the cost of storing, but the strategy eliminates downside price risk and would still allow capturing higher corn prices.

Typically farmers storing corn would like to wait until the New Year before selling to manage cash income for tax purposes. So another alternative strategy might be storing corn until after the New Year. Making cash sales at that time could potentially capture additinal basis gain and some of the market carry before re-owning on paper to capture further price gains and manage downside price risk.