It was only four years ago, but we are already getting nostalgic about the grain markets in 2012 and 2013 following a big drought which produced small grain crops in the United States, and pushed agricultural commodities to the highest price levels in a generation.
As the news sinks in across North American grain markets that the summer of 2016 has produced perhaps the biggest coarse grain crop in history, how do we adjust our marketing strategy to help our businesses succeed in a much tougher marketing environment?
The general principle of hoarding is an unsuccessful marketing strategy in situations of surplus supply. It’s both naive and inaccurate to assume that if you simply hold on to grain inventory long enough, the market will eventually come around, looking to pay top dollar for the crop tucked away in your bins. We will certainly see grain prices go up and down over the next 10 months, but they will move further and higher in the deferred delivery periods, so that’s where we need to focus our sales attention.
The chart (on this page) shows the Chicago soft wheat future’s contracts from September 2016, to July 2017. When commodities are in surplus supply, such as both corn and wheat are this year, futures contracts set up in what is called a “carry” market where the furthest away prices are the highest, and the nearby delivery prices are the lowest. The name “carry” means that the market will pay you to carry the inventory to a later delivery period, but in practical terms, it really means that you’ll need to take a discount if you want to move it quickly.
Intuitively, this market posture makes sense. In times of substantially big supply, no buyers are scrambling to make purchases in order to cover their immediate needs. If no one is under pressure to buy in their short-term consumption, then there is no need for the closest futures contract to rally higher than the forward delivery months. It’s the same as if you were driving down the road with three quarters of a tank of fuel in the truck. The price of gas at the first station that you pass would have to be extremely cheap in order to entice you to pull in for a quarter of a tank. You’d likely pay a more reasonable “market” price for gasoline if you pulled up to a station further down the highway when the pickup actually needed gas.
There is a saying in the commodity markets that, “the futures erode to the cash.” What it means is that in times of great supply, (like right now), the carry in the futures markets behave like a down bound escalator where at the bottom the nearby step is always the lowest. What it means in our graphic, is the September wheat futures is the lowest price, but when the September contract expires and goes off the board, the December contract will slip down into the price range where the lowest one was before and the new contract coming on the board (the furthest out), will be the highest priced.
The futures prices will continue to go up and down in a “carry” market, but the simple truth of the matter is that the nearby futures will need a significant rally to even catch the level where the forward months are now.
In big crop years like 2016, you want to focus your marketing on making forward sales 4 to 12 months ahead of the delivery window in order to take advantage of the futures carries, and lock in those spreads as part of your cash price. We should all still be looking for rallies in order to make grain sales, but selling the higher-priced delivery windows with carry on top of a futures rally is the easiest way to improve farm returns in a year with an otherwise sluggish market.
Did anyone forward contract 2016 crop wheat, and then feel bad about the price he got in comparison to the cash values at harvest? Those forward contracts all took advantage of locking in carry.
Steve Kell operates a crop farm in Simcoe County and is a grain merchant for Parrish and Heimbecker Ltd. in Toronto.
