This year has all the signs of producing a corn crop that could fall short of trend-line yields by 20% or more. I call this a butt-kicking drought.
Our last butt-kicking drought occurred in 1988. Yields were about 25% below trend. The drought of 1983 was nearly as severe. Beyond these years, we have to go back to the Dust Bowl. In 1934 and 1936, corn yields fell 30% short of trend.
Prices are soaring. Demand will be rationed quickly. Exports will be adjusted lower. Feed usage will be cut. Questions abound on how an ethanol mandate fits with a situation that calls for flexibility and adjustment. And you need to think about your marketing plan.
Grain marketing starts with crop insurance. I call crop revenue insurance the foundation of a marketing plan, yet I'm amazed that eligible crop goes uninsured every year. But collecting on crop insurance does not mean your farm will have a good year. Insurance products in general are not designed to make disasters a profitable occurrence.
With prices soaringyou’re thinking, “I have good insurance, but shouldn’t I do more? Shouldn’t I re-own earlier sales with call options?”
I’ve studied this type of market before – where summer prices explode. Since 1980, there have been 11 years like 2012 when December corn futures made a calendar year high between June 25 and Aug. 1 (1980, ’83, ’88, ’90, ’91, ’93, ’95, ’96, 2002, ’05 and ’08). What if I had purchased at-the-money corn calls on the day a calendar year high was established, and held it to Sept. 15? I would have lost money on nine of the 11 re-ownership attempts.
What is your alternative? Look ahead to 2013. Past market action from similar years support the old saw that “short crop have long tails” – these markets tended to spike quickly, then slowly tail off as demand is rationed. In eight of the 11 years studied above, the new-crop December contract for the following year was lower at harvest in the delivery year than it was in the year before, when prices exploded, i.e., the 2009 contract in October 2009 vs. October 2008 (see table). This was true for the 1984 and 1989 new-crop contracts, the years following 1983 and 1988. (These years shared the severity of the current drought.)
I can hear a collective groan. You want early sales in this environment? Consider the purchase of put options on 2013 new-crop contracts. They will be expensive, and this non-lover of options makes this recommendation with difficulty. But put options are free of physical delivery commitments and keep the upside open. Pricing opportunities for 2013 are reaching levels where your final price may be very good, despite the high cost of options.
Grain marketing is not easy. Marketing decisions during a butt-kicking drought are even harder.