With corn producers finding themselves in the proverbial catbird's seat as far as corn prices go, many are wondering how they can protect their position in the market. There are several ways, according to Lewis Campbell, a corn broker with South Carolina-based Palmetto Grain Brokerage.
“Volatility will be the name of the game in this market, so take your emotions out of it,” advises Campbell. “Corn used to move five cents in a week, and now it moves 20 cents in a day.”
The most common and popular way for corn growers to protect these prices is to forward contract with a grain elevator or a mill, or with someone who will protect you from market risk, says Campbell. “The good thing about forward contracting is that it protects you. If you book corn at $4 and it drops to $3, you'll be paid $4 per bushel. It also gives you a place to ship your bushels,” he says.
From a grain broker's perspective, this year's harvest is worrisome, he says. “If we plant all of these corn acres, much of it will be corn that people haven't grown in 10 years. They don't have a combine, dryer or trucks. You're starting to see a lot of the big feed mills that are full — they may not buy any more corn. They might come back later and buy some, but it might be at a lot lower basis level,” says Campbell.
Many grain elevators, he adds, have bought 500,000 to 600,000 bushels of corn, and that may be all they can physically handle in a two-month period. With all the wheat that was planted in Georgia this year, these elevators have to get rid of 300,000 to 400,000 bushels of wheat in a month to get ready for corn, says Campbell.
“From a market standpoint — in the long-term — I feel like prices could be friendly this summer. But from a harvest standpoint, I'm worried about where it all will go. If you haven't booked anything to go anywhere out of the field and you know you'll have to, you might want to start looking because a lot of places are starting to fill up.
“There are plenty of mills still buying. Some are closing their eyes and hoping we will perform this summer and make the crop,” he says.
The downside to forward contracting is that if the market goes up, you're priced out, he says. In addition, you're tied to shipping to a specific home. “If the home you're going to has trucks backed up for six miles, and it takes 10 hours to unload, that's not a good scenario for being able to harvest your corn in a timely manner.
“And if for some reason we have a bad crop year, you are responsible for filling that contract. If you priced it at $4 and it goes to $6, they still want their $4 corn. They want you to cover the contract,” says Campbell.
The second method of protecting these prices — and it's probably the producer's least favorite method, he says — is hedging in the futures market. “You pay a margin call, but there are a lot of pros to hedging. Many of these mills are buying hand-to-mouth. A lot of them are saying they'll put it on basis for you, but they won't price it — they'll price it whenever they want to. If you put corn on basis today at $4, we make a good crop, and the mill decides to price it in August at $2.75, you're at $2.75. That's a risk.
“Hedging gives you the ability to price corn whenever you want from 10:30 a.m. until 2:15 p.m. — it even trades overnight. These days, you can price corn almost 24 hours per day. If you have corn somewhere, and you want to hedge it yourself, and the buyer says he won't price it, that's fine. You can price it yourself. You could sit down today with your banker and hedge corn at over $3.50 per bushel for over three years, if that's what you want to do, and if you're comfortable with that considering your budgets.”
Hedging also leaves open shipment options, says Campbell. “That's a good and a bad thing. It doesn't tie you down to shipping to one specific home. It gives you time to look at the markets and decide if you want to take your corn to the elevator or if you want to truck it 50 miles to the nearest mill at a better price. It's a major advantage if you're growing wheat. You may have milling quality wheat, but it may rain, causing it to turn into feed wheat. Then you'll have to face discounts.”
You also can get out of hedges at anytime, he says. If you put a hedge on and something changes in the market, or you decide to get out, you can lift them at any time.
“The major downside is the margin calls. If you put on a hedge, you're going to pay margins. We encourage our customers to have futures accounts. If you're going to have one, we encourage you to get with your banker and set up an entirely separate credit line for it. Corn has gone up by $1.50 per bushel, and that eats into your operating money or extra cash quickly. A separate credit line takes the emotion out of it. And with prices being where they are, it's very easy to become tied up in the emotion of the market.”
The only thing you have to worry about when hedging with a separate credit line is that it'll cost you the interest on your money, which could add up if it goes over a long period of time and if it goes up a lot,” says Campbell.
If you do hedge, he says, there's the potential the basis will go down. “I always tell producers they can manage their basis in corn at being 10 to 15 cents per bushel to the bad side. But you can't handle corn going from $4 down to $2.50 and you haven't done anything because the mill or the elevator wouldn't price it, and all of the risk is on you as a producer to go out there and do something.”
Options, says Campbell, can be difficult to understand.
“It's like insurance on your truck. You pay $1,000 per year to an insurance company. But if you ride around for a year and don't have an accident, they don't send the premium back to you. If you do have an accident, you're glad you have insurance to pay for it.
“A put option puts a floor price on your corn. If you buy a $4 put for 20 cents, then it's a $3.80 floor. If we go through the entire year, have a bad crop in the Midwest, and corn rallies to $5, it's the same thing as riding around in your truck all year and not having an accident. They won't send back 20 cents per bushel, but you spent 20 cents and maybe pick up a dollar in the market. If we do plant the corn, make a wonderful crop, and the market drops to $2.75, that's the same as wrecking your truck — you're glad you have the insurance.”
If you get the put option, and the market drops, you're going to cash in on that insurance, he says. “Puts will leave your upside open, and you know your costs up front. If it costs you 22 cents per bushel to buy it, that's the only money you'll ever spend on it, so you know your costs up front. And it's not tied to production. You may hope you'll make 200-bushel irrigated corn, but I wouldn't bet on it, and I wouldn't book my entire crop based on it. Maybe you can get to 150 pricing and use options to protect that last 50 bushels per acre.”
If there is a weather problem, and you didn't make the crop, you don't have contracts booked that you can't ship, and you're only out the money that you spent on it to begin with, he says.
“The downside to options is that 77 percent of them expire worthless. Odds are if you buy it, it won't pay off. We use options as a risk management tool. We don't buy options to speculate or to make money. We buy options to protect you from the ‘what if’ scenario.”
A call option is the exact opposite, says Campbell, protecting you from rising prices. If you booked corn at $3.50 and the market is at $4, and you're worried about it going up, you can buy call options to protect you so that you can participate in the rally. Like put options, most of them expire worthless.”
The downside is if you buy a call option and don't price your corn, you don't have any downside protection, he notes. “If you just buy a call option and the market drops by $1.50 per bushel, you're right along with it. We may buy an option ahead of time so we'll have something to price into.”
The potential is there this summer for something we've never seen before in prices, says Campbell. “So you may buy these ahead of time so you can price your corn and go to sleep at night knowing that if the price goes to $5 or $6, that'll be okay, and maybe you'll pick up 75 cents to $1 with that option.”
If you buy a call option and don't price anything, you're leaving yourself open to downside risks, he says.
The last way to protect your crop, says Campbell, is through a hedge-to-arrive contract. “Instead of you hedging yourself and being exposed to margin calls, we do it for you. There are no margin calls with it, and you can still ship it to anyone you want, whether it's your local elevator or your local hog farmer. And you have the ability to price corn two or three years out.”
The downside is that there are costs associated with it, he says. “Some will charge you a nickel or a dime to take that risk for you in the futures market. It is tied to production, and you do have to ship that contract. If you have a crop failure, you have to fill the contract. It's like a forward contract. If you do it and the market goes up, there's nothing you can do — you can't participate in that rally unless you took another position.”
There are a lot of options available, he says, and your own futures account will become very important if prices remain high. “Buyers are pricing week to week. A lot of them won't go more than four weeks out at a time because of the risk. That puts the onus on you as a producer to take care of it yourself.”
Campbell recommends that growers watch the following factors in the corn market:
Corn exports need to slow down. The numbers are released every Thursday morning at 8:30. If you keep seeing that we're exporting 40 to 50 million bushels per week, that'll have to change.
March 31 is when the planted acres intentions report is released. This will be the next big market mover.
On June 30, the planted acres report will be updated.
Keep an eye on Midwestern basis levels. The pipeline might be running low. If you're a mill in the Southeast, and you want to buy corn now for a harvest time-frame, it's costing you 20 cents over picked up at Evansville, Ind. With freight to Georgia and a fuel surcharge, you're probably looking at 60 to 65 cents over if they want to buy corn today from the Midwest. If the Midwest runs low, the basis level might heat up because ours is the first corn in the country to come off the combine.
Keep up with weekly crop progress reports every Monday afternoon during the summer. If you start seeing 2 to 3 percent changes in the “good” to “excellent” conditions of the Midwestern crop, the market probably will react.
Watch the monthly USDA balance reports, including exports, feed use and ethanol use.
Watch funds in the market — companies like Goldman-Sachs. They'll come in and throw $300 million to $400 million at this market. They have now bought about 300,000 contracts in the U.S. corn market, and they're just speculating. They push prices far too high and far too low, but they also give you extremely good opportunities.
“We're encouraging our growers to be 20-percent priced. That seems like a low number at these price levels, but looking at supply-demand tables, we're a little worried about what could happen this summer. We're long-term friendly corn in the next year or two because of the demand that's out there,” says Campbell.
This is a good year for growers to look at options such as puts or calls, he says. “If you as a producer are going to store corn, you can put a floor under your crop at about $3.80, with your upside and basis open. That may be something to look at. We're looking forward to 2008 and 2009. If you go out and price 10 or 15 percent in 2008 and 2009 at $3.80 and $4, and if that's the worst sale you've made all year, then it has been a pretty good year. Look two or three years down the road. Your buyers won't help you do it, but you can do it yourself. It's an exciting time to be a producer.”