The title of this article borrows from Donald Trump’s book, The Art of the Deal. Given the current chaos he has stirred up, it seems fitting to reference him in a discussion on navigating uncertain markets.

Last week’s article in Grainews underscored the need for a solid grain marketing plan amid today’s market turbulence. From geopolitical uncertainty to shifting trade policies, including the threat of U.S. tariffs on Canadian grain, the marketing environment has never been more complex.

This week, we turn to the nuts and bolts of marketing: what options do you have? How do they work? And most importantly, how do they fit into an overall strategy that maximizes opportunity while managing risk?

Don’t fixate on the prices in this article. Prices vary over time and by region. Instead, focus on the concepts and marketing alternatives. Prices change, but farm marketers always have choices about how to construct a balanced plan.

Cash sales: immediate revenue

Selling grain in the cash market is simple, giving it an inherent appeal. The farmer checks with various buyers and sells to the merchant with the right price and logistical attractiveness.

Pros:

• Immediate cash flow.

• No margin or storage costs.

• Protection against future price declines.

• Eliminates concerns about quality degradation in stored grain.

• Flexible — the sale size can be adjusted based on preferences and market conditions.

Cons:

• No ability to benefit from future price gains.

• If many other farmers are also selling, it is likely to result in a relatively weak cash price.

Example: A farmer sells feed barley at $5 per bushel (all figures in Canadian dollars except where noted). The farmer has locked in that price. Future price movements no longer matter. Whether this was an attractive price or not will only be known in hindsight.

Forward contracts: Sell now, deliver later.

A forward contract allows farmers to lock in a price for a portion of their crop. The deal is done today. The delivery date is in the future, as specified in the contract.

Pros:

• Provides certainty about revenue.

• Aids farm financial planning.

• Preferable to immediate sales if today’s prices are depressed due to short-term factors.

Cons:

• If prices rise significantly after locking in, farmers miss out on higher revenue.

• Subject to production risk. If the contracted volume is not met, penalties may apply.

• May require storing the grain until a delivery date in the future if it has been harvested.

• No flexibility once the contract is signed.

Example: A farmer contracts canola at $625 per tonne for delivery later, fearing a downturn due to a trade issue. If that threat materializes and prices fall to $600, the contract provides protection. However, if the trade issue is averted, and prices rise to $650, the farmer is committed to selling at $625.

Key point: The example above assumes a direct relationship between prices and the trade disruption. While this may seem logical, it is not assured. Many other factors are in play in a complex, open global market. Keep this in mind while reading these examples. In the real world, prices may not behave as expected.

Basis contracts separate futures and cash prices

The basis is the difference between local cash and futures prices. A basis contract allows a farmer to lock in the basis. The futures price will change.

Pros:

• The farmer benefits if futures prices improve.

• Secures attractive basis levels.

• Generates cash when the basis contract is signed, based on the terms in the contract.

Cons:

• Price is still uncertain until the futures component is set.

• If futures fall after the contract is signed, the final price falls too.

• Locks in delivery commitments without guaranteeing a final price.

• Farmers may be tempted to sign basis contracts hoping futures will turn higher. This can be fatal when futures prices are persistently weak during strong bear markets. Hope is a crucial element of the human psyche — but is not a business strategy.

Example: A farmer sees a canola basis of $50 under July futures and signs a basis contract. If futures rise, the farmer benefits. But if futures fall, the final price is lower than expected. The basis stays the same — it has been locked in.

Hedging with futures

For crops with established futures markets, hedging can provide flexibility while managing downside risk. By buying or selling futures contracts, farmers can address perceived opportunities or risks, while maintaining the ability to adjust positions.

Pros:

• Provides a way to hedge against price declines without committing to a physical sale.

• Positions can be adjusted as markets shift.

• If deferred futures are above nearby futures, traders say there is a “carry.” The farmer may be able to capture the carry to get a higher price.

• If a farmer expects higher prices but does not expect to have physical grain to benefit from the move, buying futures may be a way to participate.

Cons:

• Requires margin deposits, tying up capital.

• Futures markets can be volatile, requiring active management.

• Not available for all crops (e.g., crops like peas and lentils lack futures markets).

Example: A wheat grower sees July Minneapolis wheat futures at US$6 per bushel and sells futures to hedge. If the futures price drops to US$5, the hedge gains value, offsetting losses in the cash market. However, if prices rise to US$7, the hedge results in a loss, reducing the ultimate price received.

Options: Paying for flexibility

A “call option” gives the buyer the right, but not the obligation, to purchase an underlying commodity at a predetermined price within a specified time. Conversely, a “put option” gives the buyer the right to sell the asset at the strike price within a set period. A farmer may buy a call option if they expect the price to rise. A put option is a gamble that the price will fall.

When buying a call or put option, the buyer pays a premium for the right to exercise the option, regardless of whether they choose to do so.

The strike price is the predetermined price at which the buyer can buy (call option) or sell (put option) the underlying asset.

The expiration date is the date by which the option must be exercised, after which it becomes worthless.

Pros:

• Options can be used as a form of price insurance.

• More flexibility than forward contracts or futures hedging.

Cons:

• Premiums can be expensive, particularly as they rise with increased volatility or for a deferred expiration date.

• Requires knowledge of options markets. This can involve attending an options marketing course from a grain merchant or reading relevant material from a book or the internet.

• Only available for major crops, such as canola and wheat.

Example: A farmer storing canola is worried about a drop in canola prices before they sell it. They buy a put option with a strike price of $600 per tonne. If the market price falls to $550 per tonne by the expiration date, they have effectively locked in a floor price using the put option. The gain in the value of the put option should theoretically offset the losses in the cash market from the physical sale. This is a very simplistic example but illustrates how farmers can use options to manage risk while maintaining a degree of flexibility.

Aim for agility amid uncertainty

Given the volatility in today’s market — including unknowns surrounding U.S. tariffs — strive to be nimble. There are many tools available for farm marketing. Understand them all. Utilize the ones that fit your situation and current marketing conditions. Some crops, such as lentils or peas, lack futures markets, making strategies like forward contracts or timely incremental sales even more important.

Movements by the Canadian dollar add complexity. It recently collapsed to 68 U.S. cents against the U.S. dollar, matching the lows seen in 2016 and 2020. Although sentiment is extremely negative, history suggests a corrective rally could happen at any time. A weaker Canadian dollar supports the basis and cash prices, while a rebound could pressure basis levels.

As Leonard Mlodinow notes in his book The Drunkard’s Walk, humans tend to overestimate their ability to predict the future and resist changing course when things do not go as expected. This tendency can be costly in a volatile market. Rather than try to guess what’s ahead and assume a singular result, good farm marketers are educated about — and prepared for — a range of outcomes.

Legendary investor Warren Buffett said, “Risk comes from not knowing what you’re doing.” Farmers who understand and combine different marketing strategies can balance maximizing revenue and ensuring cash flow while limiting risk in uncertain times. Whether tariffs materialize or not, uncertainty is part of modern grain marketing. Developing and implementing a diversified marketing plan increases the chance of financial success. It can even increase the odds of getting a good night’s sleep.

Caring for your marketing plan

Like a garden, a marketing plan should be nurtured so that it grows with your needs and evolves with the market. Next week’s edition of Grainews will feature an article focused on how to maintain your plan. We will also explain how to avoid getting off track — something all too easy when human emotion is involved.

The post How to use the tools to build a sound grain marketing plan appeared first on Grainews.

Basis levels are set differently by each grain company and are determined by several factors, including transportation and storage costs and the buyer’s profit margin. Currency changes also play a role for canola, since it’s traded in the futures market in U.S. dollars.

Brian Wittal, general manager of Paterson Grain’s Foothills Terminal in Bowden, Alta., believes it’s important for farmers to understand grain companies will hedge when determining basis levels as a way to manage market risk, but they’ll avoid speculating in the futures markets.

“When we hear of companies that have got into trouble, it’s because of something like that, where they take a speculative position,” says Wittal. “In the world markets, the way things can change so dramatically, that can be very dangerous.”

Most often, grain companies will offer a negative basis, or a cash price that is less than the futures price. Basis levels can turn positive though, with cash prices surging over futures prices, if there’s a general market supply shortage or when a buyer needs deliveries to cover a sale or fill a train shipment.

Supply and demand is a key part of the equation, which means buyers will typically widen their basis levels to discourage deliveries from grain suppliers (a weak basis) or narrow them to drum up more farm deliveries (a strong basis).

“What will often happen in an ebb and flow market is when prices fall, farmers become more reluctant to sell and eventually buyers will run out of products they have booked on the buy side,” says Neil Blue, a provincial crop market analyst with Alberta Agriculture. “The only way they have to encourage a farmer to continue booking with them is to strengthen the basis and, in effect, raise the cash price.”

In general terms, the strength or weakness of a basis at any point in time can be viewed as a bellwether that informs grain sellers where the market is at, and where it might be headed.

How can farmers use this market signal to their advantage? The obvious answer is a strong basis, or better yet, a positive basis, is a clear sign buyers really need grain — which for sellers means it could be a good time for a cash spot sale or to lock in that basis for a future sell.

The latter, according to Blue, can sometimes be the most profitable option. He points out when basis is strongest, it isn’t always the same time prices are at their highest — that’s because basis levels and futures prices sometimes move in opposite directions.

Blue maintains farmers can optimize their ROI if they’re able to lock in a favourable basis when prices are low; later on, should the futures market rally, they’ll have that strong basis locked in and can lock into the futures as the second step of their pricing to take advantage of higher grain prices.

Wittal says some grain companies will offer producers the option of locking in at a futures price without locking in the basis, or simply lock in a straight flat price, if that’s their preference.

“Each of those (options) is going to be a different decision and a different discussion, depending on what the market is telling (you),” he says.

Wittal believes one way grain farmers can maximize their gains is to consider historic prices and basis levels.

“If you saw an offer come out from a grain company that was above the historic level, we’d say that’s pretty good because historically (the grain company) would not be offering you a basis at this level at this time of the year,” he says. “You may want to consider locking this in on some of your grain for next year because it’s a better-than-average price.” GN

The post Have you got your basis covered? appeared first on Grainews.

Grain handling is a volume and numbers business. If grain companies don’t handle the volume, they need to “change the numbers” so they net out profitable in the end. But how do they do that if someone else is controlling the sales and handling fees?

It started back in 2012 with legislation that gave the grain companies control of their own destinies in the world of grain handling on the Prairies with the abolition of the Canadian Wheat Board (CWB) Act.

Before 2012, the CWB would sell the grain and determine what to pay the grain companies to handle your grain, and the balance after costs went back through the pools to producers.

Now the grain companies sell the grain and can set and flex their own handling fees up to government/industry set maximums. This means the grain companies take any profit or losses made on the sale plus they get their self-determined handling fees and keep it all and offer you a fair market value for your grain.

Now this is where basis comes into play. Having been in the grain-buying industry for 20 years and then work for the CWB for five years and now as an independent marketing consultant for the past 14 years, I can tell you that basis levels have changed somewhat since 2012 to today — and not in favour of you, the producer.

Back in 2006 when I started my consulting business, I can remember doing marketing strategies with producers and setting canola basis targets and hitting them constantly at levels under -$10 per tonne. In today’s world, what I would call a good basis would be a number under -$20 per tonne, and that is not near as easy to hit now as was a -$10 back then.

It is similar with wheat basis. Back then a good basis was in the +$50 to +$60 per tonne range and now a good wheat basis ranges in the +$30 to +$45 per tonne range.

Changing the numbers

Production on the Prairies is not going to increase dramatically enough to enable all of these facilities to be able to turn their facilities eight or 10 times a year. In order for them to make money, they need to make a little bit more on every tonne they handle so at the end of the year they make the same or more profit.

If total deliverable volumes on the Prairies don’t increase over time, you can expect the cost of doing business will, as shareholder and corporate profit expectations will demand it. If we have years of lower production, you may see some better basis levels as grain companies compete harder to get their hands on the fewer tonnes that are available, otherwise expect basis levels to remain static.

Before committing to a contract, ask about handling and cleaning charges as they can vary widely between companies. If you know what different companies charge, you can use that as leverage to try to negotiate a better price.

If only these grain companies were producer-owned co-ops that would pay dividends back to producers on the profits they are going to make. Wait a minute … some of them used to be, what happened?

Find out in my next column.

The post How grain companies are changing the numbers: Part 2 appeared first on Grainews.

• Read more: Understanding feeder cattle risk: Pt. 1
• Read more: Understanding feeder cattle risk: Pt. 2
• Read more: Understanding feeder cattle risk: Pt. 3

Producers used this information to calculate an expected forward price and implement an optimal risk-management program involving the Livestock Price Insurance program or using futures and options themselves. Given the favourable response, I will get into more details, but first a quick review.

The feeder cattle futures market (which trades on the CME Globex electronic platform) is the price discovery mechanism for North American feeder cattle. The contract is 50,000 pounds and is based on the CME feeder cattle index.

Without going into detail, this feeder cattle price index is based upon a sample of transactions in the 12 major feeder cattle-producing states for 700- to 899-pound medium- and larger-frame feeder steers. The CME publishes a composite price, which is the official cash settlement price for the CME feeder cattle futures at contract final settlement. Figures have been calculated by the CME Group from prices reported by the USDA.

It’s always important that producers are aware of the cash settlement price because it can vary from the futures market. We’ve seen significant speculative fund activity in the futures, which can often sway the market away from the cash direction; however, at settlement, the cash settlement price and the futures market usually converge as the funds limit their activity in advance of the deliverable month.

The local price at the auction market is called the “cash market.” The difference between the cash market and the futures market is called the “basis.” I always advise producers to convert the futures into Canadian dollars using the spot exchange rate. The basis is calculated by subtracting the cash price from the futures price. Very simply, the basis equals the futures price in Canadian dollars minus the local price at the auction market.

Example from 2017

For this project, I analyzed monthly data from January 2010 to December 2017. I calculated the average basis and the standard deviation for the data. I believe everyone understands what the average represents. The standard deviation is the quantity calculated to indicate the extent of deviation for the group as a whole. One standard deviation is approximately 68.2 per cent of the data.

In this example (see below), for 550-pound steers the basis is negative 18 so the cash price was above the futures price in Canadian dollars. Last year, I used data from 2007 to 2016 and the average on the 550-lb. steers was negative 10 but the standard deviation was the same. To make the analysis more applicable, I excluded feeder cattle during the 2009 recession because of extreme data. There was no change to the standard deviation for the 850-lb. steers and I believe the average is more representative of the current market environment.

Before we move on into deeper analysis, I want to point out how producers can use this information. During September 2017, the basis for 550-lb. steers in Manitoba was negative $20, which is very close to the average. The cash price was $20 above the futures price in Canadian dollars. For backgrounding operators, this would be an optimal time to purchase 550-lb. steers. For cow-calf operators, one could easily make the argument that they should wait until the basis is stronger. Very simply, the cash market is functioning to attract buyers when the basis is average or below average.

By November the basis for 550-lb. feeder cattle was negative $31. The cash price was $31 above the futures market in Canadian dollars. The standard deviation is 19, which means that the basis can fluctuate from plus one to negative 37. (The average negative 18 plus-or-minus the standard deviation of 19). A basis of negative 31 is in the upper end of the range of one standard deviation. The market is telling cow-calf producers this is the optimal time to sell their feeder cattle. For backgrounding operators, the market is telling them to wait until the basis is more favourable. Demand is very strong; the cash market is functioning to attract sellers when the basis is above average.

The average Manitoba cash price for 550-lb. feeders in September was $210 and in November, the average cash price was $230. By paying attention to the basis, producers have a better idea of when to sell their feeder cattle. Producers can immediately understand what the cash market is trying to accomplish.

The post More on feeder cattle risk management appeared first on Grainews.

One of the most common questions I receive is “What price can I expect when I sell my feeder cattle?” The simple exercise of using a futures market for price discovery is actually quite foreign to many operators. Secondly, many producers have a difficult time understanding the mechanics of a hedging program and the terms involved.

Some of the basics

The feeder cattle futures market (which trades on the CME Globex electronic platform) is the price discovery mechanism for North American feeder cattle. The contract is 50,000 pounds and is based on the CME feeder cattle index. Without going into detail, this index is based on a sample of transactions in the 12 major feeder cattle-producing U.S. states for 700- to 899-pound medium- and larger-frame feeder steers. As a rule, I often tell producers it is based on average U.S. prices for 800-pound steers.

One of the most important factors for western Canadian cow-calf producers to understand is the basis. The basis is the difference between the CME feeder cattle futures price and the local price at the auction market. If the March feeder cattle futures are trading at US$124 and the local price for 800-pound feeders is C$160, the basis is calculated by multiplying the futures US$124 by the exchange rate of C$1.3300/US$, which equates to C$165; then subtract the local price of C$160 for a basis of negative C$5. The futures price and the local price should be converted to the same currency. In some cases, an organization will say the basis is plus 36 which is the difference between US$124 and C$160 but this is not correct for reasons I’ll explain at a later date.

The feeder cattle futures prices takes into account the overall macro situation such as major economic changes or large changes in the fundamentals such as a drop in the North American calf crop by one million head. The basis takes into account the currency and the local situation such as a drought conditions. If there is a local drought, there will be more cattle on the market earlier, which may pressure the basis or the local price.

Follow the basis

For an example, lets say that in April a cow-calf producer plans to sell 800-pound steers in October and is wondering what price to expect. The November futures price is US$119 and multiplying US$119 by the December exchange rate of C$1.3250/US$ would equate to C$158. Using a basis of C$5, the expected forward price would be C$153. This is very important to understand the expected forward price. In April, a producer hedging calves would sell a November feeder cattle futures contract at US$119.

Let’s say in November, the producer buys back the futures contract at US$110. At the same time, the producer sells feeders at the local auction market and receives C$137. Assuming the currency stays the same at C$1.3250, the basis has widened. The feeder cattle futures at US$110 multiplied by 1.3250 minus the local price of C$137 equals C$8.75. The net result of the futures position is a gain of US$9, which is US$119 minus US$110. If we convert this US$9 to Canadian funds using the exchange of $1.3250, the gain is C$12.

The gain on the futures of C$12 is added to the actual selling price at the local auction market of C$137 for a net price of C$149. The net price in November is a bit lower than the expected forward price because the basis weakened from C$5 to C$8.75.

If the futures would have gone up to US$130, there would be a net loss on the futures of US$11 or C$14.56 (using the exchange of 1.3250). However, the local cash price would likely be around C$167.25 (US$130 times the exchange of 1.3250 minus the basis of C$5). In this case, the net price would be the local auction market price of C$167.25 minus the loss on the futures of C$14.56, which equates to C$152.70. Notice the net price is very close to the expected price because the basis stayed the same.

A futures market protects the producer but the price is not “locked in” because the basis can change over time. You won’t go broke hedging because a producer truly hedging also owns the feeder cattle. The price change at the local auction market, up or down, is offset with the change in the futures market.

The post Important to understand the futures appeared first on Grainews.