Can you read those mixed market signals?
By James D. Ritchie

A drought in hard red wheat country coupled with good supply of soft red winter wheat has made for a confusing market.

Director of grain marketing for MFA, Roger Caffrey, called it the perfect storm for a chaotic market. “Fuel costs are up, freight costs are up, interest rates are up—it’s all converging now, and it all impacts basis in a negative way. In fact, we’re seeing basis levels in some areas that I’ve never seen before,” he said.

You’ll recall that, in grain marketing, “basis” refers to the spread between local cash price and the nearby futures price for a given commodity. Essentially, basis reflects the cost of getting grain from where it’s located to where it’s needed, and usually is a negative value.

For mid-continent producers, marketing became more complicated with the wheat harvest.

“Hard red winter wheat, used mostly for flour milling, is in short supply,” said Melvin Brees, crops analyst at the Food and Agriculture Policy Research Institute at the University of Missouri. “The on-going drought in the southern Plains has cut hard wheat production and tightened up supplies.

“On the other hand, soft red winter wheat [grown by most Missouri and Arkansas producers and used primarily in pastries] is in good supply, and production projections were up by 16 percent this year. This is a unique situation: There are tight supplies of hard wheat but increasing supplies for soft red winter wheat. And I see nothing in the outlook to suggest much change in that relationship.”

The difference shows up in prices bid. Back in July, futures contracts for soft red winter wheat closed at about $3.73 per bushel; futures for hard red wheat were about $1 higher for the same month’s contracts. At the same time, cash basis on soft red wheat was taking a big hit, widening to a minus 90 cents per bushel at LaPlata, in northeast Missouri.

“Normally, river terminals have a better cash basis,” said Brees. “However, Hannibal had a basis of minus 65 cents per bushel on soft red wheat.”

All that can make things confusing. If a wheat producer heard the good news that hard red winter wheat futures were nearly $5 per bushel, but his soft red winter wheat was worth only about $3 per bushel at the local elevator, he might be tempted to think he was being ripped off.

“It’s not the elevators,” said Brees. “What’s happening is a function of supply and demand. It’s the market at work and we may not always like the way it’s working.”

Adding to the disparity between cash and futures prices is the fact that index fund managers have discovered the ag commodities futures market.

“Hedge funds have been buying commodities futures, and that throws the balance of cash and futures further out of whack,” said Caffrey. “Hedge fund managers are strictly playing with paper; they have no interest in the commodity itself and have no intention of taking delivery on the commodity or even warehouse receipts.

“Normally, cash price and the futures price come together as we near the futures maturity date,” he added. “With big hedge funds buying into the futures market, that doesn’t always happen. It further complicates the situation.”

And the complexities don’t appear to be straightening out much as you head into the field to harvest fall crops. The United States will have about 2.2 billion bushels of corn on hand when harvest begins, and soybean carryover is at near-record levels.

“There are still very mixed signals in the grain markets,” said Brees. “The wide negative basis makes for disappointing cash prices. At the same time, the corn futures price for post-harvest months is relatively high; something we rarely see in large carryover supply situations.”

And there’s nothing in sight to indicate that wide negative basis will not continue. Roger Caffrey noted that interest alone adds about one cent per month to a bushel of grain in storage, and the cost of storage itself runs another four or five cents.

“And the cost of freight continues to climb,” he said. “In June, the cost to ship a bushel of grain from St. Louis to the Gulf of Mexico was 40.7 cents. Barge transportation booked for October cost 74.8 cents per bushel.”

“With a weak corn and bean basis and big carryovers of both crops, the market seems to be signaling ‘storage,’” Brees added, noting that huge corn and bean carryovers, plus a big wheat crop have storage capacity stretched. “Can you store and still protect price?”

Those optimistic futures hold some promise of hedging grain on futures contracts and earning a premium.

“But you need to study the market,” Brees said. “Owning a futures contract could mean you’ll have to meet margin calls if the price turns against the position you have taken. In many cases, it might be safer to use options to set a floor under prices.”

For example, when corn futures were $2.80 per bushel, a put option cost 24 cents per bushel. That gives you the option to sell corn at a future date for $2.80, minus the 24-cents premium you paid up front.

“You can use more sophisticated strategies, such as buying puts and selling call options,” Brees noted. “But this means you need to watch the market even more closely.”

Further out, inventories of both world and U.S. stocks of corn and wheat are expected to decline in the year ahead. But the volatile price behavior is likely to continue for some time to come