Market Commentary for 7/26/22
Jon Scheve with weekly market commentary made on July, 25, 2022
Variables Impacting the Market
While there has been widespread hot weather, only 25% of the corn belt is experiencing drought conditions. Based on what we know today, the national yield average could still hit the 177-trend line level.
Ukraine, Russia, and Turkey signed a deal allowing grain to be exported from several Ukrainian ports in the Black Sea. The deal included conditions that require renewals every 120 days. Long-term this may create issues, but the market did not react all that negatively to it on Friday. Then on Saturday Russian missiles hit a port protected in the agreement. Today Ukrainians are claiming they will still try to export grain as the deal is outlined. This story seems far from over.
High gas prices have curtailed some usage, which means less ethanol consumption too. About 1/3 of corn used for ethanol is converted to DDGs in the production process, which means some additional feed demand could be found. However, it won’t be enough to make up for the potential corn used for ethanol demand loss.
China’s economy continues to face many financial issues, so feed demand is looking questionable there longer term. Plus, the US dollar remains strong, which makes exporting more difficult against other world exporters. On top of everything, worldwide recession concerns continue, so funds keep selling all commodities including grain on rallies.
The grain market is struggling to find reasons to be bullish in the near term as prices settle to levels similar to before the Russian invasion. However, in May the market struggled to find reasons to be bearish before things turned south.
Last week I discussed how I set basis values on 80% of my 2021 corn crop that had futures sales positions against it. Following details how I finished up on the remaining 20% of my 2021 corn crop.
I did not set futures or basis on my final 20% of production from March through May for several reasons:
The corn planting pace was one of the slowest in the last 20 years
There was an elevated chance of drought due to La Nina
The war in Ukraine meant a lot of the world corn supply may be trapped for a while
Corn export demand remained strong
There were significant logistical issues moving grain throughout the US
Risk in the futures, spread, and basis markets at that time seemed to indicate the market had more upside potential than downside risk
Basis vs Futures
Historically, basis and futures have their own market influences and dynamics, so they move independently of each other. Sometimes they can give clues to the other’s potential direction, but they are not always perfect predictors. At times it requires monitoring futures spreads for additional market information to determine potential price direction for basis and futures.
A week after Russia invaded Ukraine, I found that the July / September futures spread was ranging between a 25-50 cent inverse, seen on the chart below:
In late May with the inverse spread still present it was encouraging market participants to move grain before the end of June, when end users would stop bidding against July futures. As the market moved into June hedgers would be facing increased risk that the inverse spread would widen and/or basis values would not increase enough after June 29th to make up for the inverse that was present in the market. Plus, it seemed likely that basis values would drop further, in late June, because commercial grain facilities would likely want to sell any grain they recently acquired before basis bids against July futures were no longer available.
Last fall after harvest, my goal was to set basis at +10 against July futures, picked up on my farm, for most of my production. While I was able to sell 80% of my grain at a much higher basis value with an inverse spread trade I made (explained in last week’s newsletter), I still had 20% of my grain with no futures or basis values set on them.
From mid-March through late May basis remained far below my goal, around -20 picked up on my farm. However, by late May futures started falling, and farmers stopped selling cash corn. This pushed end users to raise their basis values to help induce cash sales. This led to a rally that pushed basis values high enough to meet my price goal. The trade I made (the red X in the chart below) was much higher than the local spot basis bids available, picked up on my farm, for that time frame.
While the chart shows basis increased another 25 cents over the next month after I made my sale, there was no guarantee basis would eventually trade that much higher. Basis had plummeted after the Ukraine invasion several months prior, and I was concerned something similar could happen like that if the market were to rally significantly again. Plus, at that time I had trucks available to move grain quickly in late May, something I was not assured of for the late June or July timeframe. In the end, I am satisfied with the trade and hitting my basis goal for the year on my final 20% of production.
Setting Basis, But Not Futures
When corn futures were at $7.75 at the end of May, I set the basis, but not the futures. At the time, while the market had pulled back 50 cents already, there were a lot of reasons to be bullish, as detailed above. This pull back seemed no different than the others the market experienced the past year, all of which were eventually followed by a rally.
To set my basis but NOT set my futures value, I made a cash trade with the end user, and then I bought July futures back at the exact same time in my hedge account. This allowed me to get paid right away for the grain I delivered, stop the cost of interest on my operating note, and did not force me to price the futures on the trade. In the end I was left with the same risk on the futures side of the trade as having an unpriced contract at an end user.
Making 90-Cents Profit
Another reason I was not in a rush to price futures on this old crop position, was because 30% of my ’22 crop was already sold with December futures at a $6.40 average in my hedge account. I knew I could roll those new crop sales in my hedge account back against my old crop positions if needed.
In late May, I figured if July futures increased back to $8 before late June, I could price the contracts out and not roll them against my new crop position. Unfortunately, futures fell through June. Therefore, I decided to move my long July positions to the December contract where my new crop sold positions were held to offset each other.
On June 27th when the July/December corn futures spread hit 90 cents, I sold my long July futures contract and at the exact same time bought back my short December futures position, noted by the red X in the chart below.
This trade had to be made before June 29th, the last trading day for the July corn contract. After that date, the July contract would go into the delivery period where most market participants do not trade. As the chart shows, the final week of trading was extremely volatile and had over a 50-cent trading range. Basically, this trade allowed me to take my $6.40 sales against the December futures and make them $7.30 sales against the July contract. This does mean I have 20% less 2022 crop sold, but I have another year to price the new crop production that is growing in the fields right now. I felt then, as I do now, that there is upside potential yet in the market. Takeaways This trade illustrates the benefits of carrying my own hedge on all my production, instead of “hedge to arrive contracts or HTA’s” with end users. The trade I made for old crop may not be to an end user I would sell corn to next year. Also, some end users do not allow customers to roll futures in inverses or roll sales between crop years. Since I carry my own hedge, I can make trades that benefit my farm operation without worrying about arbitrary rules end users may try to apply or forcing my hand to trade with an end user who doesn’t have the best bids for old crop. I’m happy with both the basis trade that hit my goal and the final outcome of the spread trade that allowed me to sell the final 20% of my corn at $7.30 futures. I have now completed the marketing of my 2021 corn crop. Next week I will summarize the final value I received for the entire ‘21 crop, including futures, basis, and storage. Plus, I will provide a snapshot of my current 2022 crop position after shifting 20% of sales to the 2021 crop.
Jon Scheve Superior Feed Ingredients, LLC
9358 Oak Ave Waconia, MN 55387 firstname.lastname@example.org