Consider Basis & Futures Carry

Consider Basis & Futures Carry

The 2011 harvest is in the bin. If you are making sales of 2011 corn or soybeans, consider what the basis is doing and how much "carry" is in the futures market.

Corn prices, which have been strong almost all year, began to slip recently after exports started declining. For farmers, the question is how long will prices tumble and what does that mean if you are holding 2011 crop corn in storage? The good news is that while futures prices have dropped compared to earlier this year, the basis remains strong. Steve Johnson, an Iowa State University Extension farm management specialist, provides the following information and observations to help you update your corn and soybean marketing strategy. 

Corn futures prices traded in a sideways pattern from mid-October to mid-November. Futures prices received little support from the November 9, 2011 USDA Crop Production and World Agricultural Supply & Demand Estimate reports. The national average corn yield had a lower forecast at an 8 year low of 146.7 bushels per acre, 1.4 bushels below the USDA's October forecast. The potential price impact of that reduction was offset by USDA's November 9 forecast that feed and residual use of corn will reach only 4.6 billion bushels during the current marketing year, 100 million bushels below the October forecast.

USDA still expects U.S. corn exports during the current marketing year to be at a 9 year low of 1.6 billion bushels. Exports have been less than 1.6 billion bushels only 6 times in the past 36 years. Through November 10, 2011 the pace of weekly export inspections for corn continued to run well below the average pace needed to reach the USDA projection for this marketing year.

Strong corn basis this fall—what does that tell you?

While futures prices for corn remain in a relatively narrow range, basis levels generally remain quite strong (top line in graph) and at record levels in some geographic locations for this time of year.

Three reasons for strong basis include: 1) Strong demand for corn; 2) Slow movement of the physical commodity; 3) Farmers' reluctance to move cash grain.

With record 2011 net farm income expected, many farmers are likely reluctant to add to 2011 taxable income. Don't anticipate much additional basis strength unless end-users really need to refill supplies. That's not likely until late January or early February. At the same time, don't expect much, if any pressure on basis this fall and winter with good domestic demand driven by ethanol production expected to use 5 billion bushels of U.S. corn again this marketing year which ends August 31, 2012.

Producers who have Hedge to Arrive (HTA) contracts established in the December 2011 futures contract should note the firm basis and lack of carry in the corn futures markets. Calculate the economics of rolling an HTA to a deferred contract vs. pricing at the spot cash basis bid available. If you choose to defer the cash proceeds until 2012 for income tax purposes, work with your grain merchandiser well in advance of delivering that grain. 

Note the lack of carry in corn futures

The futures market carry in the corn market is lacking for the post-harvest period for the 2011 crop. The December-July spread has been fluctuating between 18 and 23 cents recently. The apparent battle between current demand strength and expected weakness approaching the 2012 crop harvest continues.

If bushels are stored on-farm with lower costs and few cash flow needs this winter, holding that corn until spring should be considered. However, for bushels stored commercially, consider cash sales and replacement with a call option. This would be the same as a minimum price contract offered by many grain merchandisers. A portion of the proceeds from the sale of the cash grain will have the call option premium and small brokerage fee subtracted.

How to establish and use a minimum price strategy

Use of the July 2012 futures contract for the call option strategy is preferred, with a strike price as close to at-the-money. Using a July call option provides an opportunity should futures prices recover, especially during spring planting uncertainty. This option will expire the third week of June and increases the odds that the option might increase in value by more than the cost of the premium. Farmers who use this strategy still need to work with their merchandiser prior to the expiration of this options contract.

Soybean price outlook, basis and carry

Soybean prices have trended lower over the past month, and the January futures are now back near the early October lows. The USDA's November forecast of the U.S. average soybean yield of 41.3 bushels was 0.2 bushels below the October forecast and 2.3 bushels below the 2010 average.

The November forecast represents the lowest yield since 2008 and the second lowest since 2003. Like corn, the lower yield and production forecast generated little price strength due to a 50 million bushel reduction in the forecast of exports and a 35 million bushel increase in the forecast of year ending stocks. The pace of U.S. soybean exports remains well below that of last year.

Production prospects remain generally favorable in South America, although USDA made a modest reduction of the forecast of acreage in Argentina and Paraguay. Those reductions were offset by larger yield forecasts for Brazil and Paraguay.

In contrast to corn, soybean basis remains wider than the 15-year average (middle line) but slightly better than last year. There is some carry in the soybean futures, but not enough to reward storage, especially commercial storage. The January to July contract spread, for example, is 26 cents, compared to only about 5 cents per bushel in early September. The weak basis and concern for carry reflect the generally weak demand situation for U.S. soybeans.

Conclusion: Don't expect futures prices to stage big rally

While supply/demand remains the key drivers behind corn and soybean futures prices, the uncertainty of the macro economy is concerning to both index and commodity funds. Don't expect futures prices to stage a significant rally until this uncertainty can be mitigated or a supply shock (weather problem) develops.

Those who speculate in the futures markets will likely be reluctant to invest large sums of money while uncertainty is prevalent. Debt concerns in both the European Community and resolution in the U.S. provided by the Congressional Super Committee is critical.

Failure for resolution of these mounting debt issues in addition to the collapse of the commodity trading firm MF Global could be the tipping point for the liquidation of large quantities of long futures positions in both corn and soybean futures markets, as well as other commodity and equity markets.

Discussion for resolving debt issues could drag on throughout most of the fall and winter months, leaving supply-demand of secondary importance in discovery of price by the futures markets.

If this occurs, it could be the spring months (March, April, May) before the focus on uncertainty of 2012 supplies emerges with the northern hemisphere planting season. A rally in this time frame could provide an opportunity to finish sales of 2011 bushels and to price adequate amounts of 2012 bushels while weather remains and unknown.

The 2012 corn and soybean planted acres are expected to increase both in the U.S. and globally in response to the attractive crop prices offered. Expect global weather forecasts for the spring and summer months of 2012 to be closely followed for an indication to rebuild depleted corn and soybean ending stocks.

For farm management information and analysis, go to ISU's Ag Decision Maker site and ISU Extension farm management specialist Steve Johnson's site
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