With this series we hope to fill an important marketing need, and that corn, cotton, soybean and wheat growers can use the information to survive and prosper.
Last year, there was a large discrepancy in the bottom-line income of farmers. This was based not only on the size of the crops harvested, but also on how well crops were marketed and priced.
When we asked Alan Kluis to begin this series, he said if he was to write about concepts farmers must master to do a better job of marketing, he could write for years. We hope he does and hope that you'll benefit from the series. If you or your local bank, fertilizer dealer or county soybean association needs a marketing speaker or someone to hold a marketing workshop, feel free to contact Alan Kluis at 800-345-7692.
After college I worked as a field representative for the American Soybean Association in Minnesota and Wisconsin. In that capacity, I acted as the host for many trade teams that toured soybean processing plants, university research stations, and feed and food companies in both states.
In 1976 I vividly remember travelling to a farmer meeting in Montevideo, MN, with a group of feed manufacturers from Russia. At the time of the meeting, soybean and corn prices were low and farmers were frustrated. The farmers attending the meeting complained about the low prices and suggested that the government had to do something. One of the farmers suggested that the government had to take control of our farm markets.
The guests from Russia listened and were polite in all of their responses. After the meeting, during the three-hour drive back to Minneapolis, it was interesting to hear the comments of the Russians.
The specific quote I will never forget was: "Do they (American farmers) not know that it is only in nations that farmers have free markets that farmers are not peasants?"
The conversation that night with a group of communists reinforced my free-market beliefs that run very strong to this day. They freely admitted 17 years before the Berlin wall came down that their system was not working and that our economic system, although not perfect or always fair, worked much better.
As we enter the next century, I believe we saw major 30-year lows in the commodity markets during the last year. We're now entering a time of increased volatility, when large price swings can create great opportunities for grain and livestock farmers who are positioned correctly.
I've actively worked as a commodity advisor for over 20 years and look forward to providing you with this upcoming series of educational articles.
Lesson #1: Hedging
If you review a long-term corn and soybean chart you'll see the extreme price volatility that's taken soybean futures prices from just over $9/bu in May 1996 to $4.01/bu in July 1999. These large price swings create additional risk and opportunity for grain and livestock producers. It all depends on how you are positioned.
The need to protect against these huge price swings is why farmers should understand hedging and how they can transfer price risk. Under the current Freedom to Farm ag policy, understanding how to transfer risk has become more important than ever.
Here's an example of selling futures to lock in a profit. Let's take a real-life example of an Iowa corn and soybean farmer who rented an additional 500 acres of land in November 1998 for the 1999 crop year. That increased his total soybean acreage to 1,000 acres. With bigger rent payments due and a larger operating note at the bank, he decided to hedge and lock in the price on 25 bu/acre (25,000 bu) for delivery in December 1999 or January 2000.
On Nov. 30, 1998, he called his commodity broker and sold short five contracts (25,000 bu) of January 2000 Chicago Board of Trade (CBOT) soybean futures at $6.25/bu. By selling short on these contracts, he locked in a set price for that 25,000 bu.
If dry weather or an early freeze had rallied soybean futures sharply higher, he'd have still been locked into the $6.25 CBOT futures price. By selling the futures, he took away the downside price risk and also the potential opportunity to benefit from higher prices if values went higher later.
On Dec. 1, 1999, the Iowa farmer closed out his hedge by buying five January futures contracts. He also sold the cash soybeans because the basis at his local elevator had improved from 70 cents under the January futures at harvest to just 35 cents. By placing the hedge into the January futures and waiting for the basis to pull in, he gained over 40 cents /bu. He also prefers to haul in December, when he doesn't have to worry about road postings and long lines at the elevator.
As the summary at right illustrates, he locked in a local price of about $5.90/bu after the local basis bids from the January CBOT futures price are deducted.
Hedging works because futures and cash prices tend to move together. By placing the hedge into the January CBOT futures, he could wait for basis improvement into December before selling his cash soybeans and lifting the hedge.
This example explains why he made a good marketing decision on 50% of his anticipated soybean crop. If futures had moved sharply higher because of a drought scare, he could have sold the last 50% into that higher market. As it turned out in 1999, the 95 cents loan deficiency payment added to his $5.88 selling price, creating a profitable year of soybean farming.
The next issue will cover long hedges, locking in inputs, locking in feed or fuel costs and replacing cash sales with long futures positions. ?