Reaction to USDA’s quarterly Stocks Report, released last Thursday, was decidedly bearish. As SDSU Extension Commodity Marketing Specialist Lisa Elliot in a recent Profit Tips article, corn, soybean, and wheat stocks as of March 1 were well-above trade expectations, sending the corn market limit lower and soybean and wheat futures sharply lower as well. For livestock feeders and other corn buyers, that was welcomed news as many anticipated a bullish report that would further increase corn prices. While its important not to look a gift horse in the mouth, it’s also important for corn buyers to keep these numbers in perspective even as they have seemingly turned the trend towards lower prices for many weeks to come.
First, as Dr. Elliot also pointed out, March 1, 2013 corn stocks at 5.4 billion bushels, is historically low. Despite being almost 400 million bushels more than expected, it is about 624 million bushels (10%) less than a year ago. In fact, it is the smallest March 1 stocks inventory since 2004. Secondly, the proportion of total stocks being held in on farm storage (versus commercial storage) is much lower than normal for March 1, likely due to the reduced crop size last fall. As of March 1, 2013, farmers were storing 2.7 billion bushels of corn, or 49% of total corn stocks. A year ago, on farm storage accounted for 53% of total stocks. Back in 2004, when total stocks were smaller than this year, farmers were storing about 57% of all corn. This has important implications for livestock feeders: a larger proportion of total stocks already have moved into commercial marketing channels. Thus, livestock feeders may have to divert some corn away from other intended uses. Additionally, basis will likely have to rally in order to prompt additional farmer selling, especially given the sharp price decline following the report. Third, the increase in stocks, which implies a reduction in feed usage, came only about three weeks after USDA increased feed and residual usage by 100 million bushels in the March WASDE report. This led to expectations for a bullish stocks report and a very bearish reaction when implied feed usage was decreased. While this could provide the additional bushels to raise 2012/13 ending stocks from 632 million bushels upwards to 800-850 million bushels, it also is a reminder of how variable and unpredictable these reports have become. And, there are several more market-driving reports that will be issued before the new crop corn supply is available for feeding.
Like last year, corn buyers have been, and likely will continue to, defer as many corn purchases until fall as is possible. USDA’s Planting Intentions report, also released last Friday, confirmed trade expectations for 97.3 million acres to be planted to corn in 2013, about 145,000 acres more than 2012. USDA, and many market analysts, are using trendline yields in the 162-165 bushel per acre range to estimate 2013 production. If realized, that would likely push 2013/14 ending stocks above two billion bushels, or almost three times larger than for the current marketing year. In that event, livestock feeders would likely be able to buy corn for $4/bu or less this fall. For corn growers and livestock feeders in the western Corn Belt, the idea of trendline yields in 2013 seem almost impossible as much of the area remains firmly entrenched in drought conditions. Thus, unless weather conditions appreciably change as the growing season begins, it would appear that a trendline yield estimate will be high-water mark for this year’s corn yield, with later forecasts lowered if the drought remains. This would be supportive to corn prices. And, it is precisely what occurred during the 2012 crop year. But, unlike last year, there will be much less early-harvested corn in August and September due to later planting this spring than a year ago.
So, while last week’s reports have turned the trends and attitudes towards lower corn prices, there are several factors that provide fundamental support to corn prices or at least retain the likelihood of volatile prices for the next several months. In view of this, what are livestock feeders’ and other corn buyers’ best corn procurement strategies?
First, it’s likely that most corn buyers have secured at least a month’s corn needs prior to the reports last Thursday as they generally expected a more bullish report. Second, the 2013 corn crop, when available this fall, should offer corn buyers larger supplies and lower prices (the magnitude of which depends on the weather). So, it is likely that May through September corn needs are of most concern to livestock feeders. Option trade last Thursday implied that corn prices would have traded about another $0.20/bu lower than the limit-down prices in the nearby contracts. These lower prices should follow through to the early part of this week. This may offer an attractive opportunity for corn buyers to lock in another 1-2 months of corn needs in the cash market (protecting both basis and price level). At some point over the next few days, the corn market will likely find support as sell orders are filled and the market stabilizes. Buying another one to two months worth of corn provides coverage into the late spring and growing season when more will be known about the 2013 crop potential. For those wanting coverage for the July-September time period, a more flexible strategy might be desirable so protection from higher prices is established but lower prices could be realized. Purchasing July or September call options would be one way to accomplish this, or a maximum price contract in the cash market. An at-the-money July call option (strike price of $6.75/bu) was trading for about $0.22/bu after Thursday’s reports. The September at-the-money call (strike price of $5.60/bu) was trading for $0.42/bu. While these are relatively expensive, these calls are about $0.36/bu and $0.25/bu less than the day before. Still, the premiums are high enough that it likely removes whatever profit potential might exist from feeding cattle – especially in light of sharply higher feeder cattle prices late last week. Cheaper premiums would be available for higher strike prices. Additionally, more advanced options strategies could be used to reduce premium costs, although the level of protection generally changes then too. For example, the at-the-money call option could be purchased along with selling an out-of-the-money put option to recover some of the premium. This type of fence or collar strategy would establish a maximum purchase price as well as a minimum purchase price (due to the short put position). Alternatively, a vertical bull call strategy could be implemented by purchasing the at-the-money call option and simultaneously selling an out-of-the-money call option. This creates a position similar to a long futures position in the range between the strike prices of the two call options; however, it opens up the opportunity to benefit from prices lower than the strike price of the purchased call. But, it also provides no protection from prices higher than the strike price of the out-of-the-money call that was sold. This bull call spread is probably more appropriate for corn buyers wanting to hedge that are less concerned about a bullish market developing whereas the fence/collar strategy would provide more protection should a larger price increase occur. Again, option spreads and fences are more complicated and present certain risks, so they are most appropriate for advanced marketers with experience in hedging with options. For those with less experience hedging purchases with options, many cash grain merchants offer flexible cash contracts with similar types of protection.
Source: Darrell Mark
The information in this report is believed to be reliable and correct. However, no guarantee or warranty is provided for its accuracy or completeness. This information is provided exclusively for educational purposes and any action or inaction or decisions made as the result of reading this material is solely the responsibility of readers. The author and South Dakota State University disclaim any responsibility for loss associated with the use of this information. There is substantial risk of loss in trading commodity futures contracts and traders should consult their brokers for a full disclosure of these risks to determine whether such trading is suitable for them in light of their circumstances and financial resources.