| October 15, 2010 | Archived Issues |
Frustrations of Marketing
It seems like sometimes you just can’t win when you try to do things "right." Pre-harvest sales are supposed to capture the best prices - right? Making sales when prices are near the top of the USDA’s projected prices range seems like a good idea, doesn’t it? Doesn’t locking in a profit on expected yields make sense? Won’t selling before prices go into a seasonal decline capture good prices? If you did what seems right with pre-harvest sales, how come you missed out on more than $1.70 rally in corn and more than $2.00 in soybeans. This is even more frustrating if your yields are disappointing and the amount sold is a greater percentage of production than planned.
Grain markets have always been difficult to predict. Recently they have become more unpredictable and frustrating. It’s easy to try and blame someone or point fingers, but the fact is it is a difficult job to forecast market action with the large number of changing or uncertain factors that affect the markets. Last winter most analysts were looking at 2010-11 corn prices somewhere near $3.70 and soybean prices just under $9.00. The USDA’s first supply/demand estimates in their May reports indicated new crop corn ending stocks of a relatively large 1.8 billion plus bushels and prices ranging from $3.20 to $3.80. Some analysts thought that this carryover estimate was too low and corn ending stocks might exceed 2.0 billion bushels with prices possibly dipping below $3.00. At that time, December corn futures prices near $3.90 offered profitable returns and the USDA estimates suggested downside price risk at these price levels. The best information available at the time suggested sales should be made at these prices.
For most of the growing season, it appeared that new crop prices had peaked in early January and December futures prices continued to drift lower into late June. Throughout the summer good crop ratings suggested another huge crop was on the way. However, small production adjustments and strong demand chipped away at the projected corn ending stocks. By August, the forecast corn ending stocks had slipped to just over 1.3 billion bushels. The USDA had adjusted their price range upward and it was now from $3.50 to $4.10. December futures prices were trading from $4.10 to more than $4.30. The August price rally looked like maybe it was a "last chance rally" to price at profitable prices before they declined to seasonal harvest lows. What happened?
The September USDA estimates began to reflect disappointing corn yields in a crop many thought had looked so good. Carryover projections dropped to just over 1.1 billion bushels and the USDA made big upward shift in the forecast price range at $4.00 to $4.80!
These changes continued with the October estimates. The USDA again cut forecast yields sharply from 162.5 bpa to 155.8 bpa, which was well below pre-report trade expectations. Expected production was lowered, but demand remained strong and total use was increased. This reduced expected ending stocks to only 902 million bushels. This is a reduction of more than 900 million bushels below the original forecast in May. This resulted in another significant upward adjustment in the USDA’s forecast for prices, now expected to range from $4.60 to $5.40. This puts the mid-point average price $1.20 per bushel higher than the original forecast price in May. December 2010 corn futures have offered prices from $5.70 to more than $5.80 in recent days, with some expecting prices to reach $6.00 or more. If you sold earlier, this seems like a lot to miss out on!
Before you beat yourself up too much, remember that these are very volatile markets filled with uncertainty. It is impossible to foresee everything that may influence production, demand or prices. History shows that disciplined marketing and taking advantage of profitable prices is usually sound risk management. But sometimes the unexpected happens. Earlier sales did protect profits and that is important to business survival. In most cases, you should still have corn production for sale and this should be the focus rather than worrying about earlier sales. A similar situation exists for soybean sales as well, strong demand and lower than previously forecast carryover is also pushing up soybean prices. Still what seemed like good marketing practices produced frustrating results.
The volatile markets of recent months illustrate the limitations and lack of flexibility if only cash sales are used to make sales. The June and July 2010 issues of "Decisive Marketing" suggested using option strategies to help manage some of the uncertainty and volatility in the markets. Premiums for put options seemed expensive, but they still offered profitable price floors without committing to cash sales or delivery. Buying out-of-the-money call options was another alternative suggested. While this gave up some of the price rally, it allowed capturing some of the higher prices that were eventually offered. Using options does require an understanding of hedging and how options work, but purchasing options are relatively uncomplicated strategies to reduce risk. How well did these strategies work?
Buying Puts: In early May, a $4.00 strike price December corn put option had a premium cost of about 41 cents. In mid-July the premium for the $4.00 December put was about 30 cents. Assuming basis of about minus 50 cents, these options offered a price floor of about $3.10 to $3.20 ($4.00 strike price minus $0.30 premium minus $0.50 basis = $3.20). This may not have seemed too attractive at the time, but they did offer price protection above expected breakevens and near the low end of projected prices. These options will likely expire worthless, but with current December futures prices near $5.70, the corn can now be sold with a net cash price near $4.80 to $4.90 ($5.70 futures price minus $0.50 basis minus $0.30 expired option premium = $4.90). The net result of this flexible strategy works out much better than a cash contract sale of about $3.50 ($4.00 futures price minus $0.50 basis = $3.50) in mid-summer.
Buy out-of-money call: Suppose you entered into a forward contract sale of near $3.50 in early summer and purchased a $4.20 strike price December corn call option for a premium of about 20 to 25 cents. You would have to deliver the corn at $3.50, but the December call option now has a premium of nearly $1.50 for a gain of about $1.30. This gives a net cash price of almost $4.80 ($3.50 contract price plus $1.30 option gain).
These are just two examples of how learning how to use options can increase marketing flexibility and help manage volatile and uncertain markets. Other more complex strategies using options could have been used to lower premium costs or limit risks. Unfortunately, many producers still do not understand or use options. The bottom line is that marketing risk has increased and it is important to be able to use all of the marketing tools available. Just as adopting the use of bio-tech seeds and precision agriculture technology has been critical to increasing production and efficiency, adopting the use of new market tools is essential to risk management. Making pre-harvest cash sales can be a good strategy in most years. But in frustrating marketing years like this, more flexibility in pricing can pay big dividends!