Market Matters Blog

Last week, I published an article called "Dust Off the Storage Hedge," a back-to-basics marketing strategy that hasn't been needed the past couple of crop years because of the inverted structure of the corn market. The article is below, along with and answer to a question a reader sent me this weekend: why not skip the rolling process and hedge right off the July contract? DTN Senior Analyst Darin Newsom's response is below the story.

OMAHA (DTN) -- This year's bumper corn crop will fill many storage bins that spent the last year gathering dust. But farmers shouldn't put their corn in the bin and forget about it, DTN Senior Analyst Darin Newsom said.

"Farmers should use the carry in futures markets to hedge their grain while they wait for basis to appreciate," he said. A classic storage hedge can help farmers get a better price than they would get by simply storing grain and selling it later because farmers can capture the carry.

Carry is the price difference between futures contracts when the deferred contracts are higher priced than the nearby. When the nearby contract is priced higher than deferred contracts, the market is said to be inverted.

To set the hedge, Newsom suggested selling a December futures contract when the crop is harvested and put in the bin. Before the contract goes into delivery, farmers should buy back the December contract and sell a March futures contract, a process known as rolling.

Each futures contract covers 5,000 bushels, so farmers sell enough contracts to cover all their stored bushels.

The carry currently is around 67% of full commercial carry (also known as cost of carry), a reference point Newsom said reflects that the market is willing to keep paying farmers to store physical grain for sale later. Full commercial carry is the total cost, both storage and interest, of holding grain in commercial storage for a set period of time.

Farmers can keep rolling their contracts as long as the market continues to show a strong carry. Newsom suggested rolling contracts when the spread reflects a cost of carry that's 67% of full commercial carry or larger.

Farmers need to watch the basis throughout this process, Newsom said.

"Generally, we see a continued climb through May, and farmers could look to roll from the May to the July to take advantage of the normal basis peak in late June to early July," he said.

However, if the carry begins to weaken or narrow before the seasonal basis peak, it's a sign that the market needs more grain now. Farmers should sell some of their cash grain and buy back their futures, which closes out the position.

"We haven't had a strong carry market in quite some time," Newsom said. "It's allowing people to use traditional hedges now that some of the volatility is out of the market."

Soybeans' inverted market structure differs from corn's carry, and they should be marketed differently, he said.

"Don't sell out at harvest. I'd tuck some away, unhedged, as long as the structure stays as it is and feed the market in regular intervals," Newsom said.

He suggested farmers store soybeans commercially and try to sell the bulk of their crop within six months, before the South American crop hits the market. The inverted market should cover the commercial storage costs and farmers don't have to worry about keeping beans in condition.

Kenneth Eckhardt, a farmer from south-central Minnesota, said he forward contracted what he thought would be 50% of his soybean crop.

"But now it's looking like I'm 80-90% sold on the beans because of what a poor crop year it has been," he said. He'll likely store the rest of his soybeans at the elevator because he sees it as an easier way to access cash if he needs to purchase inputs or pay a landlord.

"It's something you can get at when there's a blizzard in Minnesota and the markets right," he said. "You can't do your marketing by whether or not the truck is going to start."

A reader's question, and Newsom's response:

Q: I understand the gain in carry. Please explain why (I should) hedge each month, why not just hedge July contract?

A: Let’s use tonight’s cost of carry table as an example.

Dec to March spread at 13.00 cents is roughly 68% of full commercial carry.

March to May spread at 8.75 cents is roughly 67% of full commercial carry.

May to July spread at 7.25 cents is roughly 55% of full commercial carry.

Situation 1: Rolling the hedge.

Given that the Dec to March spread is trending down toward a test of support at the 13.50 carry level, let’s say we sell the Dec at $4.42 with the idea of rolling the short hedge to the March at a 14 cent carry. If we get that accomplished, it will be the equivalent of a March short hedge at $4.56. Or, with the March to May spread already bearish (greater than 67% full cost of carry), we could take it all the way out to the May, putting the short-hedge price at $4.64. We would then wait on the May to July to move out to 67% (or higher) before rolling. Hypothetically, if that is 10 cents at the roll, it would put the July hedge at approximately $4.74.

Situation 2: Hedging out to the July

We could just sell the July now at about $4.70, 4 cents less than the rolling strategy. However, this would save us commission costs. Or we could wait until the contract hits $4.74 or higher, leaving cash corn unprotected until the price target is hit.

Situation 1 can be enhanced by studying the trend of the spreads and what that says about the market’s view of fundamentals. Situation 2 relies mostly on the analysis of the trend of the July contract alone.