Marketing Against the Grain

Scheve: The 3 Factors in Grain Pricing

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Market Commentary for 4/5/19
There are many variables in the corn market right now. Below is a list of reasons I think the market has upside potential or downside risk as a producer right now.
 
Reasons to Be Bullish Corn Futures

• Rain and cold weather are expected along the I-80 corridor for the next two weeks.  This may delay planting or even mean fewer acres planted.
• Recent flooding likely reduces the number of available acres planted this season.
• Weather becomes a big factor from April 10^th through July 4^th.
• December corn futures have traded above the Spring insurance prices after April 1^st every year for the past 16 years (this year the Spring price is $3.99).
• Since the ethanol mandate 12 years ago, December corn has traded above $4.17 after April 1^st every year.  In 11 of those 12 years, it traded above $4.24 (2017 was the exception).
• A China trade deal with more corn and ethanol purchased would be exciting to the market.
• Funds are carrying a relatively large short corn position.

Reasons to Be Bearish Corn Futures

• The USDA stocks reports indicate a very large US corn supply
• Acreage planting intentions plus normal yields suggest there will be more supply next year versus this year.
• Farmers are holding a massive amount of unpriced grain
• South America is expected to harvest significantly more corn than last year, competing against US corn
• African Swine Fever is decimating China's hog herds.  This could decrease overall world corn demand.
• China trade issues continue, with no end in sight
• The president has threatened to close the US-Mexican border.  It’s unclear how extensive this would be, or when it would start.

The 3 Factors in Grain Pricing 
Most farmers focus only on the cash price for their grain.  On the surface that makes sense because the cash price ultimately determines if farmers are profitable or not.  However, it's not the most advantageous number to use when selling grain.  There are three different factors that make up the cash price - futures, basis and market carry.  Savvy marketing plans and strategies optimize each of these factors individually to maximize profit potential, because each factor moves independently of the other.  

Futures
Futures have the largest influence on the final cash price, are the most volatile, and are the least predictable. Swings in the futures market can be anywhere from 75 cents in corn to more than a $1.50/bu a year for beans.

Basis
Basis is the second most important factor, but contributes much less to the bottom line.  It has less volatility than futures and generally only ranges between 20-30 cents each year. Corn basis doesn’t always move in the same direction as the futures market and it’s difficult to find a time when futures and basis are both hitting their high at the same time for the year. Basis should be evaluated separately from futures to maximize profitability.  However, basis can’t be evaluated properly without first looking at and understanding market carry.

Market Carry
Market carry is arguably the least understood factor in grain marketing, but has the most opportunity for increased profitability with minimal increased risk exposure.  Basically, market carry pays a market participant to hold or store grain until its needed.  It's a function of interest rates, storage costs and market demand.  If there is too much grain supply, the market will pay for it to be held until a later date when there is less grain available.  

Carry is often overlooked because it doesn't change much in a year.  For instance, in an average year carry may only change 1-2 cents/month for corn.  That may not seem like much, but after 10 months it could mean a 10-20 cent price difference.  For farmers trying to make a 40 cent/bu profit each year, simply watching and maximizing their market carry could mean this is where 25-50% of their profit would come from.

Most farmers don't realize that carry and basis are how grain companies make their money.  Grain companies rarely try to profit from futures because of its high volatility and unpredictability.  Instead these grain companies watch basis trends and understand market carry spreads, which allows for higher profit potential with very little risk.  
 
If the big grain companies are maximizing their profitability with basis and carry, why don't farmers do the same?  The first step is to start breaking down sales by the 3 factors and trying to maximize each one independently.

On any given day it may be a good day to sell futures, basis or just set the market carry.  However, for the corn market it has never been a good day to do all 3 on the same day. That is why selling cash grain is the least effective way to sell grain and why it limits a farmer’s profit potential. Instead breaking apart all aspects of the cash market provides farmers with the best chance to get the best possible price available to them.   

 

Want to read more by Jon Scheve?  Check out these recent articles:

The Surprise Is The Corn Stocks Not The Acreage Intentions

How I Could Get $4 For My Corn If Prices Are Above $3.80 On April 26

The Challenges of Still Having Unsold 2017 Corn

Frustrations Of The Current Market And Reasons To Be Optimistic

I'm Placing More Trades That Profit If The Market Stays Sideways For Another Month

Collecting 13 Cents Premium On 30% Of My 2018 Corn Production Over The Last 3 Months

Thinking Of The Farm As A Business

Selling Hope And Time

Tell Your Friends And Neighbors To STOP USING FREE DP

The Dreaded Margin Call And Why I Don't Fear It

The Pros And Cons Of Selling Straddles

Capturing Carry And Paying For Storage

Why I Think Buying Calls Is Gambling And Why I Avoid It

Jon Scheve
Superior Feed Ingredients, LLC
jon@superiorfeed.com
 
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