Peter Paperfarmer

Yesterday I started to address the marketing dilemma faced by too many producers on the eve of the 2009 harvest: a large crop is on its way and they are “undercontracted” for new crop delivery. What marketing alternatives are available to the undercontracted farmer?

For producers with on-farm storage, I discussed the “put it storage and pray for a rally” strategy. While it is not a cinch to make money, history (and May Sellers performance) suggests pretty good odds. But this is a big crop – what should we do with bushels where on-farm storage is no longer an alternative?

Let’s meet Peter Paperfarmer, my celebrity producer who illustrates the ever-popular strategy of re-ownership with call options. Every harvest, Peter sells his corn and soybeans off the combine, then re-owns the crop with an at-the-money July call option. He holds the options until it expires in mid-June. Peter’s performance over the last two decades (1989-2008)  is decidedly mixed, depending on whether we talk corn or soybeans, and whether we talk large or small carrying charge markets. (FYI, you can find Peter and all of my celebrity producers here.)

In corn, Peter’s re-ownership strategy made money in 4 of 20 years, or 20% of the years. It is interesting to note that, on average, Peter made money on options over the past two decades, thanks to one incredible year (2007) where a $2.75 per bushel profit more than made up for a string of 15-20 cent losses. At-the-money July’10 corn calls currently cost a little less than 40 cents per bushel.

Peter’s record in soybeans is very different. Peter profited from re-ownership in half of the years, including 7 of the past 8 years. Since 2000, the premium paid for an at-the-money call option varied widely, from 30 cents to $1.21 per bushel last year.

The conclusion looks simple enough; avoid re-ownership strategies in corn and give them a serious look in soybeans. However, we can take our understanding of Peter’s success deeper by differentiating between “large carry” and “small carry” years. Large carrying charges – defined here as the carry from December to July futures greater than 140% of interest costs – are common in the corn market (15 of the last 20 years) and uncommon in soybeans (no years).

In 15 years when carrying charges were large in corn, Peter’s re-ownership strategy made money twice. Peter’s record of success was not good in corn, and concentrating on large carry years just made it worse. And this year? Carrying charges in the corn market are very large, while they are small (as usual) in the soybean market.

My understanding is deeper but the conclusion remains the same; avoid re-ownership strategies in large carry markets (often in corn) and give them a look in small carry markets (the norm in soybeans).  As you consider re-ownership in soybeans, keep in mind that an at-the-money July’10 call will cost more than 80 cents per bushel, and that past performance is no guarantee of future results.

The harvest of 2009 is about to begin and the U.S corn and soybean farmer has a lot of work ahead of them – this will be a very large crop. USDA is projecting a corn crop just shy of 13 billion bushels, based on 80 million harvested acres and an average yield of 161.9 bushels per acre. I think the final numbers will be even larger, as I trust in the adage that “big crops get bigger.” We can expect a large soybean crop too. The USDA projects 3.25 billion bushels.

So a large crop looms and corn prices  are at or below the $3 mark in much of the corn belt, and well below cost of production. Cash soybean prices are under $9 but may be closer to production costs than corn. Word on the street is that many farmers are undercontracted, i.e. they were not as aggressive with 2009 pre-harvest sales as they had been in the previous 3-4 years. If you are one of these “undercontracted” farmers, what are your marketing alternatives?

Assuming you emptied your on-farm storage of last year’s crop, we have the trusty “put it storage and pray for a rally” strategy. May Sellers is my celebrity producer who employs this strategy every year, placing her crop into on-farm storage at harvest and selling it in late May. Over the past 10 years, May’s strategy has paid-off  seven times. In soybeans, her strategy paid-off  in eight of the last ten years. You can examine May’s year-by-year results on my website here. Her returns are estimated net of on-farm storage costs. Compare her results to Barney Binless, who represents a benchmark harvest price.

While you are comparing May to Barney, don’t forget to look at Hank Holder. Hank and May employ the same strategy – put the crop into storage and wait for higher prices. The only difference is how long they wait. May exits in late May, close to the time when average cash grain prices peak. Hank is ever the price optimist and waits too long. He is my inspriation for the 11th commandment of grain marketing, “Thou shall not hold unpriced corn or soybeans in the bin afetr July 1 (June 1 for spring wheat).”

The odds for success in the “put it in storage and pray for a rally” strategy are good. But few farmers have on-farm storage capacity for their entire crop. What can we do with the remaining bushels? Outside of building more storage capacity, I see three more alternatives; (1) sell grain at harvest and re-own with call options, (2) enter into a delayed price contract with your local elevator and, (3) enter into a basis contract.

I will address each of these alternatives in blog posts this week.

I received an interesting comment/question from a reader. Inflation and the impact onb commodity prices is foremost in his mind.

He wrote, ”As a corn and soybean farmer, I won’t be selling any of my grain until I have to clear out bin space.  It is only a matter of time until inflation is realized in our commodity markets, with a falling dollar value and rising prices in all internationally traded commodities.”

 ”Don’t you think we’re still in the high inflationary environment of 2007 & 2008, even more so with the continuing of two wars and a pending massive federal government healthcare spending plan? They just create all the money for their projects from nothing.”

I replied with the following…

I share your concerns about an inflationary environment, but the key is timing. I started worrying many months ago, and I was concerned enough to check out mortgage rates (debt is a good thing in an inflationary environment), which were running around 5.5% early in the year. Today interest rates are about 4.5% – timing is everything.

 Despite our inflationary concerns, deflation continues to rule. My Economics 101 class taught me that inflation is primarily a monetary phenomena, i.e. determined by the money supply. Money supply is determined by the quantity of money in the economy (up, up, up) times the velocity of money, or how fast it is circulating through the system (down, down, down).

 Here is my concern with a marketing strategy that calls for building more bins to hold more grain as we wait for higher prices. We run the risk of going broke before the bull market starts.

 Some analysts are calling for cash corn prices dipping below loan rates before the year is over. I can’t get that bearish, but we have a large crop to harvest and, unfortunately, I sense that a larger than normal portion of the crop has NOT been priced.

I received an interesting question via email from a producer, asking about “dollar cost averaging” of grain sales. I am guessing that his question was prompted from a reading of my column in the April 2009 issue of Corn & Soybean Digest (“Don’t Forget Last Year’s Crop”). To understand his question, it helps to know that May Sellers is a celebrity producer who stores her corn and soybean crops at harvest and sells in the last week of May. Hank Holder is a celebrity producer who also stores grain at harvest but, ever bullish, Hank waits too long, until the eve of the next harvest to sell his grain. If you haven’t caught on yet, Hank and May (and all of my celebrity producers) are figments of my imagination.

John wrote, “Why shouldn’t May and Hank use dollar cost averaging to sell their stored grain?  They should sell 11 percent of the grain stored each month from Jan to September and that way they would receive price averaging.  I am always told not to guess the bottom or the top of markets (i.e., stock market).  Why wouldn’t the same price-averaging payoff for grains as well?”

A good question deserves a response. I sent back the following… 

You may have a very good idea there, but I have a couple of thoughts. I still think that July and September are too late for cash grain sales. Over time, these sales would simply drag your average down. I can make the same argument for early sales in January and February. How about a compromise? Dollar cost average with cash grain sales over the March – June period. My characters were created to demonstrate marketing strategies and to illustrate interesting information about price patterns. I don’t expect anyone to sell all of their grain in the last week of May, ala May Sellers.

With the way the market feels, setting new L-O-C lows is not a question of if but when. The last time I visited this question in mid-July, December corn futures were trading in the area of $3.35-3.40 per bushel. This morning the market is trading below the $3.10 mark, and the L-O-C mark of $3.025 looks too close for comfort. Keep in mind that the previous L-O-C low was established three years ago, very early in the trading of the Dec’09 contract. This is the same contract that topped out above $7 per bushel in June of last year.

I note that a few analysts are talking about the possibility of an LDP – cash prices trading below the loan rate. I can’t get that bearish!

In mid-July, I pondered the possibility of establishing new life-of-contract lows in new crop contracts for corn, soybeans and spring wheat. It did not take long after that for the Minneapolis September spring wheat contract to blow through the previous L-O-C low of $5.60, on its’ way to a close under $4.92 last night. This was a contract that peaked at $12 in March of 2008. Ouch.

What happened to wheat prices? I’ve heard it said that great crops – bumper crops – are made when marginal areas of production deliver the goods. In other words, we generally expect the fertile grounds of the Red River Valley to deliver a good crop most every year. It’s when the dryland production areas of western North and South Dakota have a crop that a good crop becomes a bumper crop. I am hearing stories of 40-50 bushel wheat in significant parts of the western half of the Dakotas. And typical of a cool summer with adequate moisture, wheat farmers are wondering what to do with all these bushels while flour millers are wondering where they will find high protein wheat.

Futures price levels are pain enough – low protein discounts of $1 or more are rubbing salt in the wound.

Pre-harvest activities set the table for a post harvest plan and last year at this time, I lamented a series of pre-harvest sales that were too early and too cheap. My 2008 pre-harvest pricing committments averaged a profitable $5.70 in the September contract. Unfortunately, in late August last year, September spring wheat futures were trading nearly $3 higher.

Oh, what a difference one year makes. This year my pre-harvest sales were NOT too early and certainly not cheap – I had 75% of my crop priced at an average of $8.71, or nearly $3.50 higher than September futures at harvest. I like to remind producers of the motivation behind my pre-harvest pricing activities. I do NOT make early sales (last year, this year, any year) because my “outlook” calls for lower prices by harvest. I do NOT make early sales because of my expectations concerning the value of the dollar, the size of the Canadian wheat crop or my general expectations concerning the economy, etc. I do NOT make early sales because of a recommendation from a market advisor or broker. I make sales because I understand my own operation and my own cost of production, and these are sale prices that work for me.

Looking ahead to post harvest opportunities, I see a very large carry in the Minneapolis wheat market. By my calculation, the Sep/Mar spread of 37 cents (Sep’09 @ $5.21 1/2 and Mar’10 @ $5.58 1/2)  is 315% of interest costs to store $4.85 wheat for 6 months (based on 4.5% interest). That is the largest carrying charge in spring wheat I have seen at harvest in the past 20 years. I like to sell large carrying charges. Placing grain in storage at harvest and selling (or rolling to) the March contract allows me to, (1) hedge against lower prices, (2) capture a large, 37 cent carry from Sep’09 to Mar’’10, (3) defer income to next year and, (4) wait for a harvest basis of 74 cents under the March to strengthen. I think a spring wheat basis of 5 cents under the March is possible in the next 6 months.

My latest marketing plan should be posted by the end of today. All of my pre and post harvest marketing plans are posted on my web site.

Grain marketing is never easy – even the pros struggle with their pricing decisions. Exhibit one for your consideration: Last week I read an advisory service’s recommendation to sell the last 15% of corn and soybeans held in storage since harvest last year. Holding unpriced grain this long is clearly in violation of the 11th Commandment of Grain Marketing; “Thou shall not hold unpriced grain in storage beyond July 1.” It worked out well for soybeans – not so for corn.

Last October, Minnesota farmers were harvesting $3.50 corn. Last week the cash price was down in the $2.90 area, and we have not considered the cost of storing grain for over 10 months. The inverse in the soybean market has worked out for the Hank Holders of the world. Spot soybean prices are above the $11 mark, and much better than harvest prices in the $8.25 area (again, we should not ignore storage costs).

The story for wheat was similar to corn but worse.

Later this afternoon I will fly into Detroit in preparation for a Winning the Game program in Mason, Michigan tomorrow. I will be working with Dan Hudson of MSU Extension, based in Ingham County, to present “Launch and Land your Post Harvest Marketing Plan. The program runs from 10:00 am – 2:00 pm (arrive by 9:30 am for registration) and is located at the Monsanto Research Barn (the Haynes Farm) at 474 S. Onondaga Road, Mason MI. The cost is $15 and it includes lunch. Call 906-676-7207 for more information.

We have much to talk about. Now is the time to get your thoughts together on the ultimate question after harvest, “To store, or not to store?” Carrying charges in the wheat market are very large. Michigan producers think soft white wheat and soft red wheat (think Chicago futures) while my focus is on hard red spring wheat. It doesn’t matter – all wheat markets are sporting huge carrying charges and that speaks directly to the markets perception of ample wheat supplies and a bearish tone in the market. The corn market also shows large carrying charges. The soybean market stands apart with an inverted to flat carry.

Tonight I will fly to Rapid City in preparation of two meetings in South Dakota this week, sponsored by Midwest Cooperatives. I will present “Celebrity Squares Take the Post Harvest Marketing Challenge” on Tuesday in Pierre, and Wednesday in Philip. In this talk, I address the most fundemental of questions after harvest: “To store, or not to store?” You will meet a number of my celebrity producers as they help us understand the value in several different approaches to post harvest marketing.

Tuesday, August 25 in Pierre: Ramkota River Centre:  Amphitheatre I (2:00 pm start)

Wednesday, August 26 in Philip: Legion Hall (2:00 pm start)