During periods of unstable financial markets, commodities take on a different personality. Uncertainty breeds fear. Buyers fade out of the picture, and although farmers typically focus on the supply side of market fundamentals, the maket sees supply as only half the equation. If buyers reduce their buying, it doesn’t matter how tight supplies are on paper. Prices drop.
Credit problems in Europe have crossed the ocean, slowing buyer demand for some grains. At the same time, a weakening world economy has buyers looking for cheaper sources.
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Next we should expect a bottoming phase. This may take weeks or months to complete, but a key sign that a market has bottomed is when trade volume drops. It doesn’t matter how good the deal is, there are no buyers. That’s a sign the worst is over.
Through the first two stages, commodity prices are deflationary. Typically, interest rates also fall. World governments try to re-start their economic engines by dropping central bank rates, but with little effect. Buyers just aren’t in the mood to buy… surely this sounds familiar.
The last stage is recovery. Deflation turns back toward inflation. Commodity values start to race higher. Suddenly, the cheap cost of money makes the pace pick up. Inflation spurs a quick jump in bank rates. Talk on the market floors is that commodities are considered too cheap. Markets roar higher.
These are unsettling world times, but economic recession, deflation, falling interest rates and dropping commodity values will eventually swing to economic expansion, inflation, rising interest rates and higher commodity prices. It’s all part of the big cycle.
It takes a clear understanding of all cash contracts, futures and options trading alternatives to arm yourself with strategies for this cycle. But it’s worth the investment in time and energy.
Here are some tips to consider…
Hone Your Ability to Price Into a Rising Market: This is more easily said than done but selling into market rallies is a real marketing plus. You can price into rallies by signing a deferred delivery contract or by selling the futures as a protective hedge. Another strategy is to purchase put options. Also remember, farm storage often doesn’t pay off in bear markets.
Separate Your Delivery Decision From Your Pricing Decision: Volatile financial markets can also create wild rides in futures markets. There are times when a rally in the futures is not followed by the cash market. In other words, basis levels widen or weaken substantially. During these times, lock the futures through either a cash grain buyer or a commodity broker but be sure to maintain delivery flexibility in order to keep your futures and basis decisions separate.
Consider Direct Delivery: When grain prices get mean and ugly, loading a railcar or delivering direct to the processor will save at least elevation fees. Depending on how low prices fall into the heart of harvest, this may improve your returns substantially.
Set Pricing Targets: Basis contracts are commonly used but they don’t stick a finger in the price dike. Holders of basis contracts remain exposed to futures market gyrations. If you own a basis contract, consider setting a pricing target. You can also set a flat price target with a buyer.
Establish A Commodity Trading Account: A trading account can greatly reduce farm price risk, if managed properly. When grain is unpriced in the bin, growers can purchase put options to help insure against the risk of dropping prices. Also, growers may place a short (selling) hedge with a broker. This is called a storage hedge. The grower has sold the futures protecting unpriced grain in the bin.
Consider Futures and Call Options to Replace Cash Grain Sales: Owning paper can be a more powerful strategy than storing grain. There are several advantages to using futures and options. You can inject badly needed cash flow to meet bill payments yet take advantage of a price rebound down the road. Plus you avoid storage risk and extra handling.
Move Your Lowest-Quality Grain First: This may take a jumble of feeding it, blending it and just dumping it. Get rid of your headache first. If you are going to store, bin the good stuff. You can always replace your low quality grain with higher quality paper.
Be a Salesman: Let buyers know what you have to offer. Bring in samples, and outline reasonable price targets and tonnage available. Cementing a bond between buyer and seller is critical in any marketing process. Don’t hide your grain. Show it off.
Scout Prices for Next Year: Just like a scout for a hockey team, you must always keep an eye on rebuilding your team. Look for profitable selling opportunities months in advance. As the old saying goes, the best defence is a solid offence CG
