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A basis contract may solve your grain marketing quandry

Stu Ellis, FarmGate blog | Updated: 12/28/2012

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Where are you in your marketing plan? Did you sell out in August at the market highs? Do you still have your entire old crop either in the bin or the elevator? Did you sell your corn to shift the aflatoxin problem to someone else? Did you sell your beans because you only store corn? If you still have grain to sell and don’t like the drop in the futures price, what is there to do but continue to pay storage? Well, there is something, and you might want to strike while the iron is hot.

What determines the price of your grain? The price is a function of the futures market and the cash market, so there is a futures component and a cash component and the difference between the two is the basis. Subtract the cash from the futures price and you have the basis, which is likely a negative number, unless your local processor, ethanol plant, or feed lot is in need of grain. At that point it might be a positive number.

Iowa State University economist Steven Johnson makes the observation that a series of factors has pushed the cash price higher while the futures prices is declining, consequently anyone with grain to sell should be watching the basis quite closely. Both the corn and soybean basis are unusually tight and taking advantage of that fact can be beneficial in completing your marketing plan for the 2012 crop.

There are four independent dynamics that Johnson identifies which are pushing and pulling on the cash market to cause the basis to be where it is.

Corn and bean futures have declined. When the futures prices decline there is less interest by producers in wanting to sell into a down market. Consequently, when futures prices decline, cash prices typically rise because end users need to acquire the physical commodity.
US ending stocks are tight. With a small carryout end users know that bushels are being rationed and it may be difficult to acquire needed stocks. Consequently, cash prices will rise in an effort to acquire just enough stocks to satisfy the immediate demand.
Good demand. Both processors and exporters are seeing increased demand so they are also bidding up the cash price to obtain the physical commodity.
Lack of farmer selling. This is the end of the year, and producers don’t want to have the current calendar year reflect revenue from the 2011 crop as well as some of the 2012 crop. So your locks have rusted shut on the bin doors and the key will not be found until after the first of the new year.

Those factors have caused cash prices to rise higher than would be expected at this time in the year. While Johnson reports specific Central Iowa cash prices, let us say they are 35 cents per bushel higher than normal for corn at this time of year, and 40 cents higher for soybeans than normal at this time of year. What is more is that the basis usually improves after the first of the year as processors work through abundant supplies from harvest.

So, what can be done with this information? Johnson is an advocate of a basis contract in such situations where the basis is unusually tight. With the elevator offering a price that represents the futures price minus the basis, the cash price currently is closer to the futures price than is normally the case. A basis contract can be used to market your grain by taking advantage of the narrow basis, and then sometime later, locking in the futures portion of the price. When that occurs you have a forward contract, theoretically with a higher value due to the narrow basis.

The key to success is watching the futures price and ensuring that the contract agreement is completed before the futures price erodes further. That is one risk of the futures contract. Johnson says, “Such a risk is probably greater for soybeans than corn, as the size of the southern hemisphere strongly impacts the direction for nearby futures prices. Using the strategy for corn bushels tends to be less risky, as the seasonal corn futures prices tend to move higher in the late winter into the late spring months.”

What you also need to know is that when a basis contract is signed, the elevator will want the grain, and you will relinquish title to it. In doing so, you will be paid about 80% of the estimated value of the contract, and will receive the balance when the futures element is locked in.

Summary:

Currently, the corn and soybean basis around many areas of the Cornbelt is unusually tight because of multiple factors. This situation promotes the use of a basis contract to sell grain, giving the producer an advantage that is atypical in traditional grain marketing. Once the basis portion of the price is locked in, the seller watches the futures price move, and has the obligation to complete the contract at a later point, when the futures price is at an advantage also.

Source: FarmGate blog

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