By Jon Scheve, Superior Feed Ingredients, LLC
Wheat’s massive drop was most likely the cause for the decline in corn and beans the past couple of weeks. Large hedge funds often have positions in all three commodities, so if they were selling one, they might be selling all three.
In the last 30 days, wheat, corn, and beans had significant decreases with moderate rebounds last week:
- Wheat decreased $1 per bushel then recovered 20 cents
- Corn decreased 25 cents per bushel then recovered 14 cents
- Beans decreased 45 cents per bushel then recovered 20 cents
This week’s recovery could make technical traders think prices have found a low. If so, they may consider re-ownership or short covering of recent sales in the futures market, which could help prices trend higher.
I’ve noticed a few analysts and advisors who still have 10% to 25% of their 2017 corn unpriced. One advisor was suggesting that farmers price remaining ‘17 unsold corn if July ’19 futures hit $4. I asked this advisor how farmers, who set their basis last August or September, would show their losses rolling their futures or basis position forward. This advisor said they weren’t sure how to do that, because accounting for spread loss would hurt their average price for the year. It seemed as if they were going to just over look this problem.
Why is this a problem?
Most farmers who have on-farm storage usually can’t store more than 100% of one year’s harvest. So, if a farmer didn’t sell all of their 2017 harvested grain by September 2018, they would likely have to move the old crop grain in the bin before the start of the 2018 harvest.
When the farmer moves their grain to an end user, the farmer is going to have to make a decision as to what will happen with that grain. The market doesn’t just allow farmers to deliver grain a month or two before harvest and wait to price it for free of charge any time in the future. Likely at almost every end user there will be a cost associated to not have the grain priced by Sept. 1.
What are those costs?
As the end of summer approaches a farmer has three choices with their old crop grain that won’t be stored at home:
- Price the futures at that time and be done marketing the 2017 corn
- Pay to store their grain for 5 cents per month (or more) until a price point a farmer wants is attained
- Set the basis for August or September delivery against September ’18 futures, and then wait for a rally to set the futures price before Sept. 1
- Sell cash grain at the end of August and buy futures back in a hedge account.
Options 3 and 4 will have the exact same outcome going forward because an end user will treat the unpriced futures position the same way as having the long futures in a farmers account. Because the end user is going to want to have the basis priced as well.
Option 2 would be the worst choice as the expenses after several months will be much higher than the other choices. So unsatisfied with fall prices, most farmers in this situation probably chose option 3 (or 4) over 1. Given the market situation at the time this was understandable, but there is a cost to do this. Because the market never rallied enough in late summer, most farmers probably looked at extending the pricing period of those bushels beyond Sept. 1. That however would also have cost farmers money because end users will charge the spread between the futures months back to the farmers. In this case, that will be the spread loss from September ’18 futures to Dec ‘18 futures which was 15 cents. So basically, farmers needed prices to rally more than 15 cents before Dec. 1 to be better off than just pricing the futures in late August.
This cost is either applied to the basis value that was originally set with the end user when the delivery was being made, or it was applied to the rolling of futures in a hedge account. Again, both of these trades have the exact same outcome.
What happened if the farmer still didn’t price the futures by Dec. 1?
Likely some farmers didn’t sell and instead rolled their positions forward again this time to March ’19, but doing this meant they took another 15-cent spread loss in either their hedge account or a basis reduction. This would have then required that farmers get their grain priced before March 1.
What if farmers didn’t price the futures by March 1?
The March ’19 futures were incredibly boring and really went nowhere. So likely the farmer is probably still unpriced and had to roll their position forward again. I have seen several advisors in this situation talk about selling values against the July futures. Right now, the spread loss from March ’19 futures to July ’19 futures is 18 cents.
I have seen several advisors suggesting that farmers should look at selling July futures around $4 or so. This means taking into consideration the spread losses from last September until July, using $4.03 July ’19 futures as a price goal is the same as:
- March ’19 at: $3.85 ($4.03 – .18 spread)
- December ’18 at: $3.70 ($4.03 – .18 & -.15 spreads)
- September ’18 at: $3.55 ($4.03 – .18, -.15 & -.15 spreads)
In early December, March ’19 futures traded above $3.85 for 2 weeks. Last fall December ’18 corn futures were above $3.70 for 2 weeks. September ’18 was occasionally trading above $3.70 on and off for 2 weeks at the beginning of August.
There weren’t that many, including me, who thought any of those trades were a good idea at the time. Many spoke of all the possible reasons the market could go higher. Now farmers are hoping to just get to a level this July that was already available to them at the end of August for the 2017 crop when you account for the spread loss.
Delivering grain and waiting to price it until a later date in time is tricky and risky. Farmers will usually be fighting against the spread loss that occurs in a carry market (where futures are higher in the months after the current one). Even if they leave the crop unpriced on futures and basis and pay commercial storage they are facing an extremely steep hill to overcome. Only a huge rally can beat it, and those are not overly common and they are certainly unpredictable.
So, farmers who have unpriced grain stored on the farm aren’t facing this problem?
Farmers with on-farm storage and are unpriced at harvest won’t get charged the spread loss by rolling futures forward. That spread loss above is actually the market carry premium that so many in the trade talk about trying to capture. Unfortunately, a farmer will miss out on that carry premium if their grain isn’t sold by December 1st each year after harvestW, but at least its not an expense either. The reason its not an expense yet would be because the basis hasn’t been set. Once the basis is set then the potential for spread loss can occur.
So, it’s usually better to sell all of my crop by harvest?
With the prolonged sideways market below breakeven price levels, this is hard advice to swallow. But, if you step back and look at historical trends and costs associated with the spread loss, this is really a good rule of thumb. Like many farmers, I didn’t get all of my 2017 or even all of my 2018 corn sold before each harvest either. I did however finish up my 2017 crop before the end of August last year because I feared the type of scenario happening that I described above.
While I’m not yet completely done with my 2018 corn sales I have been continuing to try and collect premium by selling calls and straddles on my unsold 2018 corn. The trades I have been doing would limit my upside potential but I have been fearing that the market won’t go up and I would much prefer to be sold and taking advantage of the market carry opportunity. And I’m doing this even though I have 100%+ on-farm storage.
Farmers that don’t have on-farm storage have even bigger challenges if they aren’t fully sold before harvest. The odds are stacked against them as they continue to chase extreme rallies to offset their basis/spread losses.
Please email firstname.lastname@example.org with any questions or to learn more. Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.
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