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Low market value urges farmers to hold supply

Published on 4 June, 2006, Last updated at 12:03 GMT

June 4th 2006, COLUMBIA: When the futures commodity market in Chicago lists higher grain prices than prices offered by local grain elevators, the market is sending a signal to hold grain, said University of Missouri agricultural economists.

"When cash prices are low, the market is saying, "We have all of the grain we need right now" said Melvin Brees, grain market analyst with the MU Food and Agricultural Policy Research Institute.

Meanwhile, buyers bidding higher prices on the Chicago Board of Trade are saying, "This grain may be worth more later because grain supplies are expected to tighten."

A high futures price offers to pay farmers to store grain until it is needed by the market.

The difference between the local cash price and futures price is known in the grain trade as "cash basis." That difference represents grain handling costs, transportation, interest and local supply-demand balances.

"The weak cash basis is a market signal saying, "avoid cash sales" Brees said.

Abner Womack, MU FAPRI co-director, said the positive side of the current market is that there is a strong signal to sell on the futures market instead of the local cash market.

Brees said due to large carryover supplies, elevators may have limited storage space to take more grain.

"There are more than two billion bushels of corn, plus a record-setting supply of soybeans, after two large crop years," Brees said. "Winter wheat coming to market in July will be competing for elevator space now filled with corn and beans."

Although harvest-month futures price (July wheat futures) is higher than cash price, he distant months' futures (September and December) offer even higher prices.

Those distant months' higher futures prices are called "market carry" which offers to pay farmers to store, or carry, grain until it is needed by the market, Brees said.

High futures prices could pay a farmer to build a bin to store wheat. "That's something a producer must calculate carefully," Brees said. "The futures price must also pay for the risk of holding a crop in storage."

Cash basis is a signal for farmers to look for alternative markets, Brees said. "It is always a good idea for a farmer to look beyond the local elevator for a market. If the basis is 60 cents locally and only 30 cents at the nearest river terminal, that 30-cent difference can pay transportation costs to the river. A farmer with a truck can take advantage of the differential."

There may be a similar price differentials for corn at an ethanol plant or a feed mill for a swine operation.

"When any given user needs more grain, they increase cash offerings to pull in more grain. Price differentials in the market are just the market's way of allocating grain to where it is needed. The market works."

As an aside, Brees said large differences between futures prices and local cash prices may be a sign that the futures are too high.

"Local cash price may be a truer indication of the current demand for grain," Brees said. "There is a lot of speculation built into the futures price."

"Traders bidding prices up are anticipating a future shortage of grain," Brees said. "That may be because they think ethanol demand will increase sharply, or that exports to China will increase or that the weather will cause a short crop this year.

"Those are all unknowns," Brees said.

Rarely do futures price for wheat reach higher near harvest, Brees said. "Only twice in the last 20 years have harvest-time wheat prices topped $4.15 per bushel, the present prices offered on the Chicago Board of Trade."

Futures markets provide a way to lock in a price that my not be there when harvest begins, Brees said.

FAPRI economists don't necessarily recommend that wheat producers sell futures contracts to cover their potential wheat harvest.

"Selling futures contracts is a higher cost, riskier strategy," Womack said. "A less costly way to ensure a price is with options." Buying "calls" and selling "puts," or options to trade later, allows producers to bracket an acceptable price for their grain.

FAPR urges producers to sell their crop in increments when the market price covers their cost of production, and offers an acceptable profit.

Trading in futures commodities should be done only after studying potential profits--and losses, Womack said.

Trading without holding grain goes from making a hedge, which ensures a price for the crop, into gambling on the market.


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