Market Signals for New Crop Storage Decisions

At harvest time, the decision to store or sell grain can depend upon a number of factors-bin capacity, grain moisture and the need for drying, the availability or cost of commercial storage, cash flow needs, income tax considerations, etc. Sometimes it's merely a question of where the truck can be unloaded so that harvest can continue. What's often overlooked is: what are the markets telling you to do?

Futures market carry and cash market basis are price components that suggest when the market wants cash grain delivery. This allows these factors to be used as market signals to help producers decide whether or not to store grain.

Market Carry is the price premium that distant month futures have over the nearby month futures price. This premium or price spread represents what the futures market is currently offering to store or "carry" the grain until the distant month. The greater the amount of market carry, the stronger the market signal to delay sales and store grain.

Basis is the difference between the nearby month futures price and the local cash price-reflecting cash market demand and handling costs for the grain. Basis is weak when the cash price discount from the nearby futures contract price is larger than average for the local market. Weak basis signals weak cash demand and discourages immediate cash sales or delivery. In contrast, a strong basis occurs when the spread between futures and cash prices narrows (in some locations or situations a positive basis occurs when cash prices are above the nearby futures price). A strong basis suggests strong cash demand and encourages delivery of cash grain.

What signals are the markets sending for corn and soybeans as harvest begins? The September 14, 2001 USDA Supply and Demand Report, while not as much as some expected, reduced expected production for corn and soybeans over the previous report. Many market analysts expect this downward production trend to continue and demand to remain strong. Corn ending stocks are expected to decline and soybean ending stocks will be less burdensome than earlier feared. While these factors might suggest storing for higher prices if supplies tighten further, current corn and soybean markets appear to be sending contrasting signals on storage.

In the corn market, March futures have been offering a price premium of about twelve cents over the December futures contract-this represents an offer of twelve cents to store corn into the New Year. Central Missouri cash bids have averaged thirty-four to thirty-six cents under the December futures price in recent days. While basis varies throughout the state, recent years patterns suggest a potential basis improvement of ten to fifteen cents by mid winter in Central Missouri. In this example, markets appear to be offering a potential storage return of up to twenty-seven cents ($0.12 March carry plus $0.15 potential basis strength) for storage into mid or late winter in Central MO. Storage and interest costs would be roughly eleven cents per bushel for on-farm storage or about twenty cents for commercially stored corn if held into February 2002, suggesting storage profits of $0.07 to $0.16 per bushel. The markets appear to be signaling-store corn!

March soybean futures are currently a $0.10 to $0.11 premium over the November contract. This contrasts to a March carry of about twenty cents a year ago. Current Central Missouri cash bids are about twenty cents under the November futures contract, a much stronger basis than in recent years. A year ago, Central Missouri cash bids were forty cents or more under the November futures price! In addition, at some scattered locations, January 2002 cash bids are less than current price offers. While basis will likely weaken as harvest progresses, the opportunity for basis gains appears very limited-especially when compared to recent years. For now, markets appear to only offer about $0.10 (March carry and little potential for basis gain) for storing soybeans into mid winter. Storage and interest costs would be about $0.16 for on-farm storage or $0.24 for commercial storage of soybeans into February. The current soybean markets appear to be signaling-don't store soybeans!

Further reductions in production estimates and tightening of grain supplies could produce higher prices. While these price gains could be captured with stored grain, they can also be captured with futures market positions without the risks associated with grain storage. While there are other business reasons for storing grain, it is important to remember that recent year's storage returns have depended heavily on capturing market carry and basis gains.

Harvest is just getting started throughout the country and market signals may change as harvest progresses into October. Currently it appears that storage returns are possible for corn, but storage returns for soybeans may be hard to come by without significant price rallies. If the business goal is to speculate on higher prices, it might be better to shift the risk into the futures market instead of storing cash soybeans.

Why We Need the Futures Market

The Chicago Board of Trade (CBOT) and other commodity exchanges were closed for three days following the terrorist attack in New York and Washington D.C. The other most recent closing during normal trading days occurred in April 1992 when the CBOT was closed due to flooding. Both closings illustrate the importance of having a transparent and liquid market. Without open trading, grain prices are essentially unknown. In both cases, grain buyers were reluctant to accept the risk of buying grain without the ability to price it.

The closing in 1992 caused only minor disruptions, since it was in the early spring and at a time of slower grain movement. It did hamper feed buyers and those who needed to fill grain needs on a daily basis, because there was no grain price for a few days.

The recent closing resulted in even more uncertainty. It occurred as corn harvest was in progress in many areas and corn was being delivered to market. Recent corn prices had been near CCC loan prices resulting in a loan deficiency payment (LDP) of three cents per bushel or less in most of Missouri. Both buyers and sellers were concerned that corn prices could be sharply lower whenever the CBOT reopened. However, program rules made it impossible to adjust the LDP during the period and producers, who delivered grain for sale, could only claim the LDP based on the posted county prices (PCP) determined prior to the attack. They were faced with the possibility of receiving a much lower cash price and eligibility for only a three-cent LDP. The only way to avoid this problem was to maintain ownership of the grain (beneficial interest) instead of delivering it for sale.

Fortunately, when trade reopened, the markets didn't "crash." While the ultimate effects of the closing were minimal, it reminded everyone how important the futures market is to grain marketing and price discovery. While some like it and others "cuss it' the futures market is necessary to insure prices are discovered each day and readily available to everyone.

Protect the LDP?

The low prices of recent years have made the marketing loan provisions of the current government program a part of everyone's marketing strategies. The Loan Deficiency Payment (LDP) is frequently used not as a price protection tool, but as a speculative tool to enhance the cash price received. Producers often collect the LDP and then hold the cash grain waiting (hoping) for higher prices with the goal of receiving a net price that is higher than the county loan price.

In some situations, such as this year when production is uncertain and there is potential for price rallies, the eligible LDP amount may shrink before the grain can be harvested and the LDP claimed. When this situation arises, some market advisors begin suggesting strategies to "protect the LDP!"

Strategies to protect the LDP usually involve buying call options (possibly buying futures) in anticipation that if prices rise, gains on the options premium (or futures contract) will offset the shrinking amount of LDP. While this may work, farmers need to understand the shortcomings or problems that might occur with this strategy.

First, the LDP is the difference between the posted county price (PCP) and the county loan price. The PCP is based upon cash markets and can be affected by basis. If the LDP shrinks due to changes in basis, call options (futures) won't protect it.

Second, buying a call option (futures contract) before the cash grain is harvested or sold creates a double long position. The producer is long (owns) both the cash grain and a futures buy position. It should be understood that this is a speculative position-speculating on higher prices.

Finally, if a call option is used to protect the LDP, the anticipated loss of LDP should exceed the amount of option premium (cost). If prices aren't going up enough to offset the option premium, then it doesn't make sense to spend more on the protection than it is expected to return.

The late soybean crop in most of Northern Missouri and the possibility of downward adjustments in USDA's production estimates could result in price rallies before the crop is harvested and eligible for the LDP. Protecting the LDP by purchasing a call option might work, but it is important to understand the strategy and especially how the cash market affects the LDP.