Follow the Signals

Futures spreads reflect fundamentals but are also pulled and tugged these days by outside forces. Managed money and even the algorithmic trading firms can quickly concentrate enough volume in nearby or deferred futures months to distort spreads as well — even if temporarily. (As funds built a record-large position in soybean futures, was it really “right” fundamentally for November 12 soybeans to trade as high as $2.30 over July 13 or did it reflect “big money’s” focus on owning November futures?)

Carries can develop in futures, but they are not likely to be as generous as in recent years. December/March corn at 6-7¢ wouldn’t be attractive most years, but it may be generous this season, for example.

Where futures remain inverted and basis is strong, markets tell hedgers to liquidate ownership. Follow the signals. The next step is to sell Delayed Price inventor(ies) and go short the basis. This turns a futures inverse in your favor; your farm customers will price their DP bushels later at what should be a lower basis. For example, shorting the basis on DP soybeans at some location at a basis of +20Jan for November delivery is a much higher basis value when futures are steeply inverted. On a recent day in harvest the Jan/March soybean inverse was 40¢ and Jan 13/July 13 was at a $1.36 inverse.

+20 Jan sale for November

= +60 March (40¢ Jan/March inverse)

= +156 July (136¢ Jan/July 13 inverse)

Selling soybeans equivalent to +156 July and having farmers price them in early summer looks like a good strategy. But if you plan to sell DP soybeans due to the inverse, also lock in the inverse by buying the deferred futures month and selling the nearby. Then when you sell the cash soybeans (against January futures for example) and take January futures, the January futures position is offset and the long hedge is fixed in the deferred months. You could lock in the inverse(s) in portions using different spreads, based on when you think producers are most likely to price.

Some firms are offering incentives to farmers to put soybeans on DP instead of storing their soybeans or putting them in farm bins. Such incentives could include no DP service charges for soybeans priced by Aug. 31. Or the farmer might get a small premium over the elevator’s published bid on any soybeans priced after May 1.

Futures often retreat seasonally during harvest but watch potential credit needs closely. Prices are higher this year and for many firms, the value of their total inventories may be no more than 10% above last year at this point. But if price has to work even higher to ration demand, your credit needs could escalate rapidly. Watch the signals.

Recognize that some traditional plays just won’t work in a crop year such as 2012. Feed mills and crushers, for example, can’t justify carrying owned-inventories of corn and soybeans from harvest until summer when corn or soybean futures are inverted, just to ensure having products you can offer for forward slots at traditional basis values. Doing things that make no economic sense is not the road to success. Instead, quote forward product basis as the market dictates — no matter how high the value is or how much the buyer may complain. You need to be compensated to take on the risks someone else is trying to eliminate.

Train-loading firms will face special challenges. Originating sufficient inventories will get tougher in many areas as the crop year progresses. Soybean exports will fall dramatically by spring and corn will slow as well. Local domestic markets are going to dominate much of the crop year, taking away freight advantages and putting small elevators on equal footing with sub-terminals.

Mike and Jason, along with elevator managers around the country, have a tough job this crop year. Credit demands will remain high, volatility raises the cost of mistakes, and it’s easy to get discouraged or to second-guess your plans. Your financial exposure is higher due to the risk that some weaker end user/buyers could fail. Focus on the big picture: Rationing demand requires sustained high prices, atypical grain flows will occur, and opportunities may arise unexpectedly. The advantage goes to firms that can react quickly and are sufficiently capitalized to weather the storm. Follow the signals.

Diana Klemme is a longtime contributor to Feed & Grain. Contact her at Grain Service Corporation, Atlanta, GA, by calling (800) 845-7103 or email at diana@grainservice.com.