Years ago I had the privilege of learning about grain futures and cash markets from Professor Reese Dahl at the University of Minnesota. Much of what he taught remains in the course I teach today, “Agricultural Futures and Options Markets.” Reese shared a short list of bullet points concerning basis, or the difference between cash and futures prices. These bullet points are still relevant today. Let me share them with you, followed by a few comments of my own.
- Basis patterns in storable commodities (i.e. grains) are broadly similar from one year to the next. It is convergence – the merging of cash and futures prices at the delivery point and in the delivery month – that is at the core of “broadly similar” patterns. The lack of convergence in corn, soybean and wheat markets has been a point of contention in recent years. Rule changes centering on variable storage rates seem to be helping but the jury is still out on whether or not convergence problems have been completely solved.
- Different grains have different amounts of basis regularity – corn and soybean basis patterns are generally more regular than those for wheat. I think this remains true today. Wheat is a food grain with a more complex set of quality standards. This contributes to the greater irregularity in the wheat basis.
- One of the principal factors causing year to year variation in basis is the supply and demand for storage. Still true. Do you get a better bid from your local elevator when their storage bins are empty or full?
- Variability in the local basis for grains is heavily influenced by the supply and cost of transportation. Amen to this point. When floods shut down the roads or slow barge traffic, your local cash price suffers while the world (as reflected in futures prices) views your situation with indifference.
- Basis for grains is more erratic in inverted markets. Inverted markets rule when supplies are short. The corn market is inverted – September futures are trading at a premium to new crop December futures. A quick scan of the country on my CashGrainBids.com website shows nearby corn basis levels from 20 cents under to 100 cents over, with sharp changes noted daily. That’s erratic.
- Judgment and skill in forecasting the basis is the guts of making money in the grain business under a hedging operation. By definition, hedgers offset every cash purchaser with the sale of futures and vice-versa. Because of their offsetting positions, hedgers are not concerned about flat price changes (e.g., whether the price of soybeans is $13 or $10). They are concerned about the relative value of their two positions, which is measured by basis.
Reese knew his grain markets.