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Making your grain marketing plan

Getting started with the basics of basis and futures

Trade wars, weather delays, low-quality grains, lower-than-hoped-for prices. When your crop is finally in the bin, this might be a good year to learn more about marketing so you can make the most of what you have.

There are many different ways to market grains and some are better suited to certain crops. Some crops have a futures market, others don’t. For crops that are futures-traded, you can use basis as a marketing strategy, if you understand how basis works. There are different quality ratings and ideal movement periods for different crops that can put some extra dollars in your pocket. If you’re new to these terms or need a refresher, this article will give you some ideas about where to start digging in deeper.

Futures markets

Futures market provide a mechanism for buyers and sellers to lock in a profit for a future date. If you contract grain today but the price changes a couple of months from now, if you’ve been using the futures market, your profits may be protected.

So why do only around seven per cent of North American grain and oilseed farmers use the futures market for hedging purposes, whereas with buyers it’s closer to 90 or 95 per cent?

“I think the reason is that it’s confusing and complex, and there are many factors — namely speculators — who participate in those markets,” says Brennan Turner, owner of online grain marketplace, FarmLead. “Many farmers are asking whether it’s worth the hassle of trying to play in the futures markets versus dealing in the cash markets and being done with it, considering that they have so many other things that are going on in their operations that they need to focus on.”

There are futures markets for major crops including corn, canola, oats, wheat and soybeans, but paper trading is still a lot different from cash trading and many farmers still believe that cash is king. “Regardless if you hedge or not, you still have to sell into the physical cash grain market place and that is certainly what pays the bills,” says Turner.

In reality, few farmers use futures markets to hedge canola and oats because these markets are not very liquid, that is, there aren’t many participants in the market compared to crops like corn that are bought and sold in greater volume. This can make it challenging to manage your position.

There are plenty of online resources for farmers who want to learn more about futures markets, but hedging can quickly turn into speculating and can lead anyone down a shaky path, cautions Turner. “If you’re not the expert, rely on an expert,” says Turner. “Learning how the futures markets operate and trade will not be done in a three-day seminar. It’s a skill-set that takes years to hone and more often than not, a lot of producers, instead of just focusing on protecting their profits, start to speculate. If they’re not just trying to protect their bottom line, but they’re starting to think ‘I could have made more money’, that’s where they can start to get into trouble.”

Turner advises farmers to keep it simple. “I know farmers, for example, who only will hedge for production,” he says. “Once it’s in the bin, that is essentially their hedge, they’re thinking, ‘I’m long in market otherwise I wouldn’t have this in the bin right now.’”

Forward contracting

Don’t confuse forward contracting with futures contracts. Forward contracting refers to cash markets; buying a futures contract is for hedging purposes. “The main thing to understand is forward contracting specifically relates to the cash grain market,” says Turner. “It’s an opportunity to lock in a price for tomorrow’s delivery, instead of contracting grain at harvest time just because a farmer needs cash flow. The likelihood is that the price today for that future delivery date will be better than the price at harvest time which is generally the worst time to sell. So, again they are locking in liquidity.”

Some farmers are reluctant to lock in a contract on grain that isn’t yet in the bin, so Turner advises forward contracting a percentage of the crop to reduce risk. “What would be the likelihood that a farmer isn’t going to produce at least 20 or 30 per cent of their crop? So why wouldn’t they lock in the price on that amount and reduce their exposure potential for a decrease in price?”

Crops that don’t have futures markets include pulses and feed grains, although oats are primarily sold in the cash market too. Because sellers usually have to ask for a price or be willing to accept a price offered by a buyer, it’s important to do some comparison shopping to find out what prices are being offered locally.

For crops for which there aren’t any futures markets, there are only a couple of options to protect against downward price risk. One is forward contracting, the other is deferred delivery. “Instead of moving the grain in the spot market tomorrow, you lock it in today and deliver it two or three months down the road,” says Turner.

Using the Basis

Basis is a marketing tool that can only be used for crops that have a futures market, such as canola, corn, wheat and soybeans.

Basis reflects the local supply and demand for a crop. It’s calculated as the difference between local cash prices and the futures market price. Local buyers set the basis, which can be an indicator encouraging or discouraging delivery of commodities. Basis can be affected by many factors such as local storage capacity, transportation costs or weather-related issues. Basis is usually negative because the local price is generally less than the futures price. In times when a commodity is scarce, or a buyer has an urgent need for a specific grain, basis can turn positive — in this case, the local price is higher than the futures price. A positive basis is good for the seller — the farmer can lock in the basis and wait for the futures price to rise again to make extra cash.

It only makes sense, though, to lock in basis when it’s moving towards the positive (narrowing) rather than widening (getting more negative). It doesn’t make sense to lock in a basis contract on a commodity (for example wheat) that is flooded with new supply and the basis widens, but if suddenly wheat is in short supply and the basis looks to be narrowing, it’s a good time to lock in a basis contract, protecting a higher local price. Once the futures prices rise again, the farmer can combine the strong basis price and a higher futures price to make more money.

Basis can be confusing in Canada because buyers have two options; a default basis, or a currency basis.

The default basis simply uses the futures price. For example, if the futures price on hard red spring wheat in Minneapolis is US$6/bushel, but the local cash price is $7.25/bu. (in Canadian dollars), the default basis would be +$1.25. That is, the default value ($6) plus $1.25 to get the cash price.

The currency basis automatically factors in the currency difference. If the U.S. dollar is trading at 1.3 Canadian, US$6 multiplied by 1.3 is $7.80. If the cash price is $7.25 then the currency basis is -55 cents/bushel.

Currency plays a huge part in Canadian grain marketing in futures markets where grains are priced in U.S. dollars. It can get complicated, fast. What’s simpler to understand is that seasonal trends affect basis.

“We know that at certain times of the year, the basis is going to be strong, i.e. when you have strong export demand.”

Know your risk limit

Many farmers avoid dabbling with futures and basis because there are too many variables to factor in, and ultimately, it’s always a gamble, says Turner. “If you locked in basis today, you think that basis is going to get worse or the futures market is going to get better. Whereas if you lock in the futures contract, you think futures are going to get worse and basis is going to get better,” he says. “It requires diligence to stay on top of things.”

Turner suggests baby steps for farmers interested in hedging. “I’d suggest maybe starting with five or 10 per cent of their production to play around with in the basis markets and leverage the experts, including talking to multiple local grain merchandizers and get their perspective on the market.”

Quality matters

Quality factors affect prices. For wheat, you’ll need to know falling numbers, HVK content, disease levels, bushel weight, protein levels and moisture content. Discounts and premiums are generally applied for these factors at delivery time. It’s hard to plan for these price changes in advance, and protect yourself against the risk of seeing large discounts when you deliver lower-quality than expected.

“Whatever the discount schedules are at that exact moment, when the trucks are delivered, is hard to know,” says Turner. “They change every year. So, farmers should try and push for getting some of that contracted if they can, because most companies will agree to some terms, but not necessarily the entire contract to get that protection.”

Another option is to contract your grain at a lower grade. For example, instead of contracting your wheat as No. 1, 13.5 per cent protein, contract at a No. 2, 12.5 per cent protein. If you produce a higher quality, you may be better off capturing the premiums than taking the discount you would have received if you’d contracted for a No. 1 and grown a No. 2.

Selling at the right time

Each crop has an ideal movement period. Generally, during or right after harvest there is a surplus on the market so prices are the lowest. If cash flow and storage capacity allow, selling later, when prices tend to rise, is a good marketing strategy.

That said, this year, the usual seasonal patterns were disrupted by geopolitical risk. Nothing is guaranteed in commodity markets.

There is generally a weather premium in the late May to early June. “You’re usually going to see the highs of the market, historically speaking, around this time, depending on the type of the crop,” says Turner. “For crops that are maybe a little bit closer to the Canadian border — like canola, hard red spring wheat — those crops tend to peak about a week after the highs of the corn and soybean market have been made, mainly because of concerns about growing season conditions.”

It’s never bad to try to sell or price into the strength of the markets. If the market is going higher, nobody knows exactly when it’s going to top out, but if you can lock in a good price on five per cent of your production and then another five per cent at $0.10/bu. more you will be in a good position.

“The thing about the futures, the growing season timeframe is good,” says Turner. “Then, you usually see a little bit of a premium even in canola around November/December/January timeframe.” Last winter, Turner says, “it didn’t really happen,” due to geopolitical risk and surplus crops. “No matter what, if there’s a big crop, it tends to take away from some of the seasonality.”

Pulses are often affected by weather conditions in other growing regions, such as India and the Black Sea region, which has become a big player, particularly in lentils and peas. Large buyers like China and India affect pea and lentil prices, which generally see their lows in late July/early August and strengthen around December to February, and May to June when global supplies are dwindling.

An example of changes due to geopolitical risk is India’s decision to impose import tariffs on peas and lentils. “That completely took the legs out from under the market,” says Turner. “One of my strong recommendations is to watch for the downside risk in the market. In late October 2017, before the tariffs came into place, there was talk of these tariffs happening and when they did finally come in, yellow pea prices dropped about $2/bu., within days. Quite literally, these best times to sell can change based on geopolitical environments, so farmers need to stay on top of these different factors.”

Keeping up with the market

There is no end to the information available to keep on top of global trends and factors affecting markets. It’s not always easy to weed out the “noise,” says Turner.

Turner suggests farmers get into the habit of making notes to build their own historical records they can look back on to try and make sense of some of the trends.

“Farmers write a lot of other stuff down, like precision ag, metrics, how much fertilizer was applied, seeding variables, because it’s going into an equation to grow their crop. Why shouldn’t they be doing this for their marketing — writing down the different factors that are impacting the sale price of their grain,” says Turner. “When they write it down, they can review it and that’s what the best hedge fund managers do. If they think back over the last year, and they were waiting for a better price and the price went backwards, timestamp that and set a calendar event in their phone calendar to remind them that this time last year, they should have sold and they didn’t and they’re not going to let that happen again.”

Grain marketing is like any other skill set — it takes work and can get frustrating. Reading and attending seminars will help you amass a body of knowledge to help you understand markets and make more profitable marketing decisions.

“I am a strong believer that those people who are in tune with their crops and know what’s going on in the field, when they should be spraying or harvesting, will have a greater likelihood of better production,” says Turner. “If they’re in tune with what’s happening and affecting their market, the likelihood that they’re going to be able to profit more is a lot higher. Be an active participant, especially once the crop is in, because that’s money sitting in the bin. It’s staying there, it’s an unpriced asset and if you don’t focus on what’s affecting that unpriced asset, then are you actually going to be able to capture the best possible profit for your operation?”

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About the author

Contributor

Angela Lovell is a freelance writer based in Manitou, Manitoba. Visit her website at http://alovell.ca or follow her on Twitter @angelalovell10.

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