Late December, 2020
We have all heard, Cash is King. The King goes first when doing the math for a basis contract.
Why is it important to make sure you understand the math?
Many times over the decades I have seen merchandisers take advantage of farmers. This past week, an Iowa farmer contacted me. He had corn in the bin, and the local cash bid was $4.70 after the close of the CBOT that day with July futures settlement of $4.72. We discussed the math and all the “ins and outs” of the merchandiser lingo. I made sure the farmer knew what to expect and what the final answer should be.
About 30 minutes later, the farmer called me back, and the discussion with the merchandiser he described went something like this:
“I told the merchandiser I wanted to deliver my corn in January, but I wanted to set up a July basis contract.”
Merchandiser: “Ok, we can do that. Let’s see, that would be 8 under the July.”
Farmer: “How do you figure that? Cash corn is $4.70 for January delivery, and July futures are $4.72. That is not 8 under the July.”
The merchandiser was visibly uncomfortable. He started mumbling about the rolls from March to May and May to July and then said, “Well, we can do it for 5 under the July.”
He had gone from the dictatorial phase of the discussion to the negotiation phase. By now, the farmer had little doubt that his math was right. I had told him that would happen, and to stick to the math: “Cash is King”. Whenever the merchandiser tries to get away from 2 under the July, I told the farmer go back to the math and tell him, “$4.70 cash minus $4.72 July = two under the July.”
That is what the farmer did three times and finally the merchandiser said, “Oh, now I understand what you want to do. You want to deliver the corn in January and put it on a July basis contract! Yes, the basis would be 2 under July.” Well, yeah, that is what the farmer said in his first sentence.
What did the farmer accomplish? He stopped the negative return to storage of about 5 cents a month, he maintained a long position in the corn market, and he kept the merchandiser from fleecing him of 6 cents a bushel on 37,000 bushels, which amounted to $2,220.
Better yet, the farmer will never be taken advantage of again when it comes to setting up basis contracts.