On the surface, the futures trade last week looked flat. The net change for the week was up $2. In fact, the last seven sessions have seen closes within a $4 range. A digestion phase after the run-up? Underneath the surface, things are changing. We have shifted the fund shorts over to the industry. Wood is now hedged. We have also shifted some of the industry longs over to new fund longs. The makeup of the futures market today is friendly. It is not a signal to buy, but it could generate higher prices on its own.
The futures market is closed on Monday the 15th, so January expires on Friday. The current open interest is normal for five sessions to go. With the growing industry’s short number, we may see some upward pressure again. We could see a shift to expirations now having an upward bias.
As far as the cash market goes, it remains fluid. That has been the case for months now. It has the feel of the covid slowdown that never occurred. This time, we spent a year expecting a recession and higher unemployment. What we found was steady business.
With mills coming back online and wholesalers owning wood, it could be sloppy for a while. The funds are the key.
The Leonard Lumber Report is a column that focuses on the lumber futures market’s highs and lows and everything else in between. Our very own, Brian Leonard, risk analyst, will provide weekly commentary on the industry’s wood product sectors.
Corn has been rage bound for the last two weeks with no catalysts in the market to move it much either direction. The weather in South America has improved slightly in areas that got off to a tough start but doesn’t seem to have made much a difference on the market. It is still a wait and see approach for the South American crop, nobody wants to jump to conclusions. Th Biden administration is supporting tax credits for ethanol-based sustainable aviation fuel, which would result in a major new demand source down the road. The markets will likely be muted in both volume and price movement as we head into the end of the year.
Soybeans have bounced around the last couple of weeks with a steady stream of exports and the Argentinian peso devaluation. The latest crush report from NOPA recorded a record for the month and about 3 million bushels more than pre-report estimates. The demand for beans has been there and seems to be significant but with so much time still to go before South America’s crop is known. Estimates keep shrinking the Bazil crop, which the market shrugs off, making it a hard market to be overly bullish in when good news is not met with good market reactions.
The equity markets continued their run higher this week as the Fed kept rates steady and seem likely to begin cuts in 2024. The rest of the market has begun participating as the Magnificent 7 stocks had done most of the heavy lifting to this point. Analysts are still warry of a soft landing recession but for now the markets are moving higher in the short term.
Whether you’re a producer, end-user, commercial operator, RCM AG Services helps protect revenues and control costs through its suite of hedging tools and network of buyers/sellers — Contact Ag Specialist Brady Lawrence today at 312-858-4049 or [email protected].
The lumber market today has three defined pillars. The first is supply and demand. The other is rates, and then there is inventory management attitudes. All are currently indicating more of the same for 2024. What could be different is inventory management.
This past month we saw a much more robust buy round. There was a genuine attitude that buying cash at $370 or $375 held a low risk. We saw that again with the lack of hedging after a $50 run in futures. Most believed that inventory management was sufficient. Distribution and wholesalers want to hold more product. Contracts and VMI limit the availability of wood at any given time. The fact that the industry was able to have a good buy round indicates a shift at the mills to hold more wood. That is good for prices in a flat market. A Weyerhaeuser guy (Jay) always said that it is bullish when the mills control the wood. When they ship it to others it is bearish. Let’s see if that is the case next year.
Last week’s negative trade reflected the lack of hedging by the industry. The end-of-the-year timeframe is rough for those holding inventories. Another sloppy week is expected. The massive liquidation in the futures market takes it out of the game to help at this point.
Technical:
The futures market retraced 38% of the move last week. The 50% mark is 518.00 and the 61% is 509.70. All are in reach. What is a little more bullish is the fact that the lower Bollinger band sits at 520.50. It would take time and work to get that band to turn down. I am looking for a lower trade in January, but the timing may be closer to expiration.
Note: fund managers point to a possible shift in the fund makeup in lumber from short to long. Rates will control that conversation.
Note: the sleeper in this market is the monthly inventory of new homes available. This last number of 7.8 months is the highest we have seen in three years.
The Leonard Lumber Report is a column that focuses on the lumber futures market’s highs and lows and everything else in between. Our very own, Brian Leonard, risk analyst, will provide weekly commentary on the industry’s wood product sectors.
Corn has had a rough month as it continues its sideways to lower grind after briefly touching $5.20 in October for the March contract. While there has not been any major market news to direct the market a strong weekly export report this week was welcome to the market that had been bleeding lower. The last few days saw a nice reversal, seeing a 14-cent rally off this week’s lows. Basis has taken a nosedive in many areas of the country hinting that there may be more corn out there than initially expected. With harvest all but wrapped up for most of the country it will be worth keeping an eye on whether farmers store the corn and hope for better basis or get it off their books to pay back operating loans at the highest rates we have seen in years. Brazil’s weather remains about the same with beneficial rains expected over the next couple of weeks in the drier areas north and the south remains wet.
Soybeans have fallen over the last couple of weeks but is in a sideways trade in the big picture. Exports were not as strong as corn but better than expected. Brazil’s weather is the main focus for beans right now as the north is drier than normal and the south is still wet. The bean demand from China is welcome, as always, but sustained demand and not just demand while Brazil is having logistic issues will be important. The amount of rain in Brazil next week will be the main market mover until the report on Friday if we get some surprises.
The equity markets had a great November seeing strong gains across the board as the Fed speak has turned dovish and inflation continues to cool. The markets are pricing in the Fed beginning to cut rates in the first half of 2024 while the general consensus by large companies and funds is that a mild recession is still in the cards next year. The big names had a good month and the 10-year note fell, but it was encouraging to see some laggards join the party. The end of the year always involves some shuffling, but economic data will continue to move the markets now that earnings are past.
Charlie Munger passed away this week at the age of 99. A longtime investor and one of the brightest minds for financial markets the Berkshire Hathaway investor left his mark and knowledge on the financial markets.
The next WASDE Report is Friday, December 8 at 12 ET
Brazil is set to join OPEC+. Brazil produces about 3.7 million barrels a day which makes it a top 10 oil producing country.
The ceasefire between Israel and Hamas ended as hostage swap negotiations stalled. The unrest in the Middle East will continue to dominate headlines.
Whether you’re a producer, end-user, commercial operator, RCM AG Services helps protect revenues and control costs through its suite of hedging tools and network of buyers/sellers — Contact Ag Specialist Brady Lawrence today at 312-858-4049 or [email protected].
Futures trading has been around for hundreds of years with the first exchange, Dojima Rice Exchange, starting in Japan in 1730.
The United States got its first official commodity trading exchange in 1848 when the Chicago Board of Trade (CBOT) was created. Chicago was the ideal location for the exchange with rail lines and proximity to the heartland of American agriculture and an already booming metropolis. As one would expect, corn, soybeans, and wheat were among the first futures contracts traded with corn leading the way.
Eventually the CBOT merged with the CME (Chicago Mercantile Exchange) to form the CME Group that exists today as the world’s largest financial derivatives exchange. While futures and options are used to trade several asset classes through the CME, we will focus on the agriculture sector and the uses there.
What are Futures and Options?
Futures and options are tools that traders use to both speculate and hedge. A futures contract is a legally binding financial instrument that allows someone to buy or sell a standardized asset for delivery at a set future time for a set price. Futures are different from forward contracts because of the standardized contracts, and they are traded on exchanges. While a forward may be customized with the point of delivery the contracts traded on exchange have defined contract amounts (see chart below).
An options contract is the right but NOT the obligation between two parties to make a potential transaction of an underlying security at a preset price before or on the expiration date.
As we go through all the uses and potential ways futures and options can be used here are some questions you should be able to answer at the end.
What are the basic uses of futures and options?
What advantages and disadvantages does using futures and options have?
How can I use these as risk management tools?
How to calculate the profit or loss from a trade?
Hedging with Futures
Hedging in the futures world can best be thought of as a type of insurance. It is used to manage the risk that prices could move adversely to your interests. Hedging is used in all markets to manage positions and reduce exposure to various risks including but not limited to dramatic increases or decrease in price.
Hedging is used in the production agriculture industry to help protect downward price movements and for buyers/ end users to lock in prices for goods that will be sold/bought in the future. Whether you are a farmer selling your crop or an end user buying the grain there are hedge strategies that are available for your operation.
While futures are the most straight forward method of hedging, options are also very popular as they provide some flexibility. Let’s look at a couple examples:
Ex. You are a producer and want to hedge the risk of prices moving lower:
A farmer believes the basis, currently -$0.20, will improve over the next couple months but is happy with a $6.50 futures price. They sell $6.50 March futures while storing the grain. They were right and basis is flat come February, but the price fell to $6.40. This would result in a final price of $6.50 for the farmer minus fees and commissions ($0.10 trade profit + $0.00 basis + $6.40 cash price – fees and commissions). If they had just made the sale at the time when basis was -$0.20 they would have only received a price of $6.30.
On the other side if prices had gone up to $7.00 and basis had remained at -$0.20 the farmer would receive that $6.30 price minus fees and commissions ($7.00 price at time of sale to elevator -$0.50 loss from trade – $0.20 basis – fees and commissions = $6.30). If they were right about basis and it did improve to $0.00, then the price they would receive is $6.50 minus fees and commissions ($7.00 price from elevator – $0.50 loss from trade + $0.00 basis – fees and commissions)
*Fees and commissions vary by broker
Ex. You are an end user that buys grain to feed cattle.
The feeder is comfortable paying current prices because they believe they can make a profit locking in part of the input costs at current levels but is worried prices will move higher. They buy 25,000 bushels for a future month (let’s use July) for $6.00. If prices go up to $6.50 when it is time to buy the corn in July, basis remains the same, they will save themselves $.50 cents a bushel or a total of $12,500 – minus any fees and commissions* ($6.50 x 25,000 = $162,500; $6.00 x 25,000 = $150,000). In this scenario they were right and were able to protect against adverse price movements and save themselves money.
If they had been wrong and prices moved lower by 50 cents, then they would have cost themselves $12,500. The payoff of hedging comes with knowing you have certain prices locked in and help set ceilings and floors to help you budget and manage risk.
While these are some straightforward ways in which futures can be used to hedge, there are other strategies that traders employ that may be specific to the customer. For more information on hedging grains check out the education courses on the CME Group website.
Hedging with Options
Being long an options contract is the right, but not the obligation, to buy or sell the underlying futures contract at a predetermined price on or before a given date in the future. Many customers like these because they require less capital up front, but that does not eliminate risk. Below the charts show the difference in movement.
Options can be used to reduce uncertainty and limit loss without significantly reducing the potential returns from the other side. There are put and call options that each have different uses and strategies around. Here is an example with each.
Ex. You are a farmer looking to limit downside risk.
1 Dec corn put option is bought for 20 cents per bushel with a strike of $6.50 expiring in Nov. The 1 contract represents 5,000 bushels. The farmer is risking the $1,000 + commissions and fees he paid up front (5,000 bu x $0.20) to protect a move lower. If the price when the option approaches maturity of Dec corn is $6.00 then the farmer successfully protected that $6.50 price while risking the $0.20 (the option would cost around $0.50 then and you would sell it to get out of it or exercise it and get assigned a short position from $6.50). The total profit on the trade would be $0.30 less commissions (Option strike price of $6.50 – Market settlement $6.00 – cost of the option $0.20).
If the price had moved higher to $7.00 you would benefit from the higher price to make your sale but the $0.20 you paid for the option would be worth close to $0.00, making your actual price $6.80.
Ex. You are an end user looking to limit the upside price risk.
1 Dec corn call option is bought for 20 cents with a strike of $6.50 expiring in Nov. The end user is risking the $1,000 + commissions and fees he paid up front to protect against a move higher. If the price when the option approaches maturity of Dec corn is $7.00 then you are protected against that move while risking the $0.20. The option would be worth close to 50 cents ($2,500-commissions and fees – the cost of the option $1,000 for a total profit of $1,500 per contract).
If the price had moved lower to $6.00 then you would benefit from buying at a lower price but would lose the 20 cents with the price of the option being close to $0.00, making your real purchase price closer to $6.20.
There are advantages and disadvantages to using either hedging strategy, so it is important to think about what you are trying to accomplish when taking a position. The advantages include ease of pricing, liquidity, and price risk hedging. By actively hedging you can work to limit the price risk or lock in prices that you like or believe can lock in a profit margin for your business. The disadvantages are the risk of being wrong and adverse price movements against your position. As shown above, while these tools can be very helpful it is important to understand their limitations and risks.
Speculation
Futures and options are also used in the markets every day for speculative purposes allowing for additional volume and liquidity to support the hedging side of the market. That said, with additional volume comes increased volatility and price movement forcing all market participants (hedgers and speculators) to be highly focused on managing risk and profit margins. Practically, the examples above work the same way for someone trading these contracts that do not deal with the physical side.
Futures initial margin is the amount of money that you must deposit in advance of entering a futures position with the FCM (Futures Clearing Merchant). Unlike the margin in a stock account, there is no money being borrowed or an interest rate to be paid for using house funds. Rather, margin is cold / hard cash deposited by the customer in their account at the FCM that acts like a partial downpayment to hold the position. If the market moves against the initial trade, traders can expect that additional funds will need to be deposited.
Similar to futures margin, option margins are an important factor when using options strategies. Margin is the cash an investor must have on deposit as collateral before purchasing (buying) or writing (selling) options. Often times, the initial margin requirement for an option is low; however, there are more factors to consider with option margin pricing – including but not limited to changes in volatility or the proximity to option expiration.
In the case of both futures and options, margin requirements are set by the exchanges and change from time to time at the sole discretion of either the exchange or FCM.
Maintenance margin is the minimum equity an investor must hold in the account after the purchase to continue to hold the position.
Expiration and Settlement
Expiration dates vary based on the derivative being traded but is the last day that derivatives contracts are valid. Most option contracts are closed or rolled before expiration to avoid assignment.
If the futures contract is held too long, then the customer could risk being assigned delivery. Over 95% of the derivatives are exited early but there are options to take delivery should that be desired.
A link to the expiration calendar can be found here.
Summary
In summary, futures and options trading offer a dynamic landscape for both hedging and speculative purposes. Whether you’re a farmer safeguarding against price fluctuations or a trader seeking to capitalize on market movements, understanding these financial instruments is crucial.
The advantages of ease of pricing and liquidity come hand in hand with the responsibility to manage risks diligently. As we’ve explored the intricacies of hedging with futures and options, delving into the significance of margin requirements and the nuances of expiration and settlement, it’s evident that these tools wield immense potential when managed properly.
RCM Ag Services
Farmers, producers and end users have special needs that our experienced hedging/ag trading team have been working through with clients for years. Improve your hedging strategy by making use of RCM’s market analysis and discussing hedge solutions with our local experienced agricultural advisors. Contact us Here: https://rcmagservices.com/contact/
To dive even deeper into the world of futures and options, explore the education materials on the CME Group website here.
Grain storage has expanded across the country over the last decades as farmers try and time selling to maximize profit potential. While holding the grain until you decide to make a sale is one option, there are several different strategies when it comes to managing the grain. In this short piece we will look at the 4 main strategies and talk about the potential benefits and risks.
1. Hold in bin
As stated above the “sit and hold” method is the most basic and long used method of grain storage. This method makes you long the market as you hope that prices go up from harvest levels over the course of the next year. You are long the market because you will only profit if prices go up, if prices go lower, you miss out on what a sale at harvest could have been.
Here are a few risks that come with this method:
Price deterioration
If prices for future months is lower, or moves lower before your sale, you miss out on the price difference between harvest price and sale price. There are numerous factors that can cause this making it your biggest risk.
Cost of storage
Running storage bins to keep the quality of the grain at deliverable levels costs money that will cut into the profit potential the longer it is stored.
Act of God
While insurance covers AOGs in most situations it is still very much a risk as many farmers face the threat of strong storms and the damage that comes with it.
Now the potential benefits:
Price appreciation
The price for future months could go higher, by either improving futures prices or improved basis, and you could potentially profit making a sale at a higher price (minus the extra costs of storage)
Taxes
The timing of sales obviously affects your income, meaning there will always be taxes involved. Pay them now or pay them later…Uncle Sam always wins, but if you can write off against income, DO IT.
These are the basic costs and benefits of this method. While this is the most popular method it does carry the risk of prices falling below your breakeven from factors completely out of your control. Now let’s look at the other methods that involve active risk management.
2. Sell and re-own the board
This strategy is for farmers who do not want to store the grain, or do not have the storage, but don’t want to miss out on the potential of higher prices. You can sell the grain to your preferred elevator (lock in a future delivery or current) and buy futures or options to try and take advantage of a price increase. The downside to this is that if the prices move lower, you lose whatever difference is between your sale and the future price.
Examples:
You sell 10,000 bushels of corn for $6.50 Dec contract with +$0.20 basis for a $6.70 sale. You think prices are going to go up over the winter, so you purchase 2 March futures contracts at the current market value of $6.60. Your hunch was correct and March futures goes up to $7.00 and you take profit on your trade by selling them to capture the $0.40 profit minus fees and commissions*. This makes your corn sale equal to $7.10 ($6.50 sale + $0.40 trade profit + $0.20 basis – minus fees and commissions* = $7.10).
Now suppose you were wrong, and prices go down. Using the same information above but prices of the March contract go lower to $6.20. This would result in a loss of $0.40 plus fees and commissions making the value of your corn sale equal to $6.30 – fees and commissions* ($6.50 sale – $0.40 cent trade loss + $0.20 basis – fees and commissions* = $6.30).
*Fees and commissions vary by broker
If the thought of large losses of sales scares people there are other options, such as using options. You can use option trades to limit the capital risk using specific strategies (not all will limit capital risk as some will increase the loss potential). These strategies are not suitable for all investors and each farmer should discuss the risk associated with such trading with their broker or elevator where they offer. For more information on options click here.
3. Sell for delivery in future month
Some farmers will store the grain themselves after selling it for a future delivery month. This strategy is used by farmers when the price difference is worth the cost of storage or they like the futures price but believe basis will improve. Historically, in a “normal market”, the future months will offer some premium to the current month for the crop marketing year. This is because of the risk and unknowns that are present in the market.
Example:
The March contract for corn is trading 15 cents higher than December. If the farmer can store the grain for less than 15 cents leading up to the delivery period, they would consider this sale to capitalize in the margins.
The other way farmers try to maximize selling for future delivery and storage is basis. Elevators change their basis based upon demand in the area. If farmers like the futures price, but no the basis, they may elect this method hoping basis improves.
4. Hold and sell futures against
The final strategy we will discuss is storing grain, while selling futures against it. Farmers will do this if they think the market price is strong, but the basis is poor, or they are unsure of the price direction but do not want to miss out on current levels. This is a way of locking in the futures price on the bushels while allowing time for basis improvement, but not total price risk. If prices move up from when you sell the futures, what you get paid when you decide to sell the physical grain will make up the difference in what your trade lost. On the other side if the price goes down your trade profit makes up for the difference in the cash price come time of sale.
Example:
A farmer believes basis, currently -$0.20, will improve over the next couple months but is happy with a $6.50 price. They sell $6.50 March futures while storing the grain. They were right and basis is flat come February, but the price fell to $6.40. This would result in a final price of $6.50 for the farmer minus fees and commissions ($0.10 trade profit + $0.00 basis + $6.40 cash price – fees and commissions). If they had just made the sale at the time when basis was -$0.20 they would have only received a price of $6.30.
On the other side if prices had gone up to $7.00 and basis had remained at -$0.20 the farmer would receive that $6.30 price minus fees and commissions ($7.00 price at time of sale to elevator -$0.50 loss from trade – $0.20 basis – fees and commissions = $6.30). If they were right about basis and if did improve to $0.00, then the price they would receive is $6.50 minus fees and commissions ($7.00 price from elevator – $0.50 loss from trade + $0.00 basis – fees and commissions).
This is one of the more straightforward strategies as it establishes the price of the sale limiting market factors to only effect basis.
While there are many strategies farmers employ with their stored grain, these are the most common. Each farmer faces their own unique challenges in producing a crop but the decisions about when and how to sell effects everyone. There is no cookie cutter plan as one strategy may make more sense for one farmer than another, therefore it is important to have a plan. Knowing your breakeven and having a marketing plan and sticking to it are how farmers can be successful year in and year out.
This week’s back and forth trading in futures highlighted just how difficult it is to manage inventories in today’s marketplace. The problem is insufficient real-time data to read supply or demand accurately. We saw the industry going from a too much wood attitude on Monday to a now enough by Friday. That type of uncertainty has plagued this industry for years. In the recent past, many took to contracts, which has taken out some of the emotion but has also reduced margins. This buy sides self-prescribed shrinking of margins causes voids in the market.
The reluctance of other buyers and pure demand also adds to the voids. So, where are we going with this? We can’t keep this beast full in a rising market.
The marketplace continues to argue about business. 1899 is a big permit number and too large to produce for. We hear all about the actual completion number, labor, windows, yada, yada, yada. The permit number is either business for today, potential business, or soon to be postponed business. Most economists were in the same camp for years that we couldn’t build 1.5 because of labor, and we couldn’t produce 1.5 because of log issues. If the industry can’t complete 1.5 and there isn’t enough wood available for 1.5, why are permits rising to almost 1.9? The simple answer is increasing demand. Covid, the Fed, and the stock market have hyperbole the housing sector.
The Fed flooded the system with cash that sent the stock market to new highs giving many a large windfall. Throw the urban bail into the mix, and here we are. From here, the question becomes whether these levels are sustainable, and the quick answer is no. The longer answer is that the world has changed, and attitudes towards money have changed, as has investing. It will take years for this industry to get a read on the net result of that change. History has shown that industries learn to be more efficient, but higher prices stay.
Too many or not enough issues are the primary cause of our large swings as it “encourages” the algo’s to push the market. The market experiences temporary slowdowns in purchases which negatively impacts prices in futures. We saw early last week how quickly the market focuses on supply and shuts off. As we look towards better shipping and more Euro wood, I expect the industry to take a large step back. Prices will fall sharply, but with 1.9 permits, it won’t stay down for long.
Let’s Get Technical:
There are two views diverging views of the current lumber chart. The non-lumber technicians see a market consolidating to go sharply higher, and it is a pattern of a market cliff dwelling to seasoned lumber technicians. Who is seeing it correctly? The issue today is that lumber has historically been a pure momentum-driven market, and it corrects but rarely will it maintain a flat trading area at a top or bottom.
We have two weeks of a flat market hit by a shutdown announcement and a Russian invasion. Our first takeaway is that the marketplace is accepting these higher prices levels, and it is a market looking for the middle. That said, as a seasoned lumber technician, I would not be too exposed to a possible cliff in front of us.
Weekly Round-Up:
First and foremost, betting on cheaper wood is not a good business strategy. July is sitting close to $1,000, which is $300 under March futures and cash. I am looking for a spring selloff, but the math indicates a continued tight market for months. The entire industry will sell in May and go away after last year will keep inventories very low. As the technical section says, the industry is trying to find some middle ground for pricing but keeps getting caught in the logistics. There is a better cash trade, and the industry is adding a few hedges along the way. The funds are adding a few longs on every spike, but nothing could lead to a trend.
About The Leonard Report
The Leonard Lumber Report is a new column that focuses on the lumber futures market’s highs and lows and everything else in between. Our very own, Brian Leonard, risk analyst, will provide weekly commentary on the industry’s wood product sectors.
Before You Go…
A special guest joins us for this episode of The Hedged Edge, who is well known for his many titles, which include Doctor, Editor-in-Chief, Dean, and Chief Academic Officer, just to name a few. Dr. Channa S. Prakash, Dean of the College of Arts and Sciences (CAS) at Tuskegee University, has served as faculty since 1989 and is a professor of crop genetics, biotechnology, and genomics. He is also well recognized for mentoring underrepresented minority students.
Tune in as biotech guru Dr. Prakash discusses everything from Alabama football, genetics as one of the most extensive agricultural advancements, the most significant risk factors to feeding the world over the next 30-50 years, plus everything in between. And as a bonus, we find out what sport he would be interested in playing if he went professional.
It has been an exciting week in futures as it traded each of the five sessions. There was continued volatility, but March closed virtually unchanged from a week ago. That’s progress. We saw that the CME upped the limits, and we’ll also see an article in the WSJ this week referencing the constant limit moves we have. Notoriety is good. At the same time, there has been a slow creep high in total open interest.
It has been a while since the futures and cash markets were this close. However, we’re not sure the futures market is that close to the cash market after hearing numerous reports of cash trades over $1,400. It looks like the market has paused to take a look.
Lumber has always been an industry that would buy into an uptrend and hedge into a downtrend, and there wasn’t much pre-positioning. The same is in place today where a switch is flipped, and we all see the panic on the buy-side. Then another switch is flipped, and you can’t find a buyer. This doesn’t take days or weeks but just hours. The massive cost of a carload of lumber is compounding the problem today. Since we don’t buy on the way down or sell up, there is a large void created on every move.
The last time we sat around $1,200, the momentum indicated a potential for a $400 move in either direction, and it turned out to be down. May is $100 cheaper than March, and July is $100 cheaper than May. The futures market is trying to smooth out the downside, and the upside will organically be smoothed out with time. Coming into Monday, there is a controlled burn to the downside, but the upside could find some running room.
We all know that any hint of better transportation will cause a sell-off. This week, we saw a little pressure from a BC mill finally shipping a few cars to the U.S. on Sunday, February 20. It just seems a little early to get the ball back.
Let’s Get Technical:
The focus here will be on the longer-term chart pattern and its momentum indicators. The most scrutinized area is the last gap left from 1114.90 to 1069.90. (Weekly) a closing of that gap in the March contract would be very negative. It should hold for now and then be an objective after expiration. The market is sitting right on a resistance line at 1264.30. It isn’t a firm point but does come off last year’s high. One positive to note is that the market made a new high on this move taking out the previous high from January. $1,336 is a new weekly high. Finally, if another leg is up, it will take a shot at the weekly gap of 1,514.80 to 1,540.00. The current RSI is at 68%. It hit 94% last year.
The technical read is slightly friendly but primarily neutral. The least resistance is up, as is most of the pain.
Weekly Round-Up:
Let’s take a look back at rising open interest. There is a new segment of the industry using derivatives for risk mitigation. Most of it is coming from the buy-side. This has been a slow-moving process but is now starting to bear some fruit. Obviously, our volatility keeps many out or limits their exposure, but they are around. The March contract shows more signing of a squeeze than any long-term relief. That said, this is a bottomless pit. The rollover will be violent this time, with the mills adding to the downside. We are again building a transit inventory mess, but the issues seem to have longer legs this time. It will drag through March expiration, but will it drag through May’s?
The Leonard Lumber Report is a new column that focuses on the lumber futures market’s highs and lows and everything else in between. Our very own, Brian Leonard, risk analyst, will provide weekly commentary on the industry’s wood product sectors.
Before You Go…
A special guest joins us for this episode of The Hedged Edge, who is well known for his many titles, which include Doctor, Editor-in-Chief, Dean, and Chief Academic Officer, just to name a few. Dr. Channa S. Prakash, Dean of the College of Arts and Sciences (CAS) at Tuskegee University, has served as faculty since 1989 and is a professor of crop genetics, biotechnology, and genomics. He is also well recognized for mentoring underrepresented minority students.
Tune in as biotech guru Dr. Prakash discusses everything from Alabama football, genetics as one of the most extensive agricultural advancements, the most significant risk factors to feeding the world over the next 30-50 years, plus everything in between. And as a bonus, we find out what sport he would be interested in playing if he went professional.
As of 2022, there are 7.9 billion people in the world, which is anticipated to hit 10 billion by 2050
Did you know that by 2050, the world is expected to feed almost 2 billion more people than we do today? As the global population continuously rises, a significant amount of food will need to be produced over the next 30 years.
But before you get to overwhelmed with that thought, it’s imperative to know that the need for more production creates opportunities. In fact, in 2020 alone, 19.7 million jobs were related to the agriculture and food sectors. We cover these areas in this What It Takes To Feed the World infographic. So, let’s take a closer look into how each of these categories work together to help pave the way to feeding 25% more of the population over the next couple of years. Here’s everything you’ll need to know:
Download the Infographic
FINANCIAL INSTITUTIONS / INSURANCE
Due to inflation (we cover farm inflation here) and superior advancements in farming technology (seed, equipment, etc.), the cost of doing business is extraordinary.
As a result, banks and other financial institutions have become the pillar of the agriculture community. From financing farmers, purchase of seeds and chemicals to providing insurance to protect the farmers on through to commercial lending and trade finance programs; without banks, agriculture, as we know it today, does not exist. As a standalone example, consider that in the U.S. alone, during 2020, farm bank’ lending was $98.6 billion despite the global economic slowdown. As the demand to produce continues to grow, there is minimal question that the need for capital will grow along with it.
Source: Federal Deposit Insurance Corporation & American Bankers Association Analysis
SEED / CHEMICAL:
Before the farmers can get to work, they need seeds and, subsequently, fertilizers (watch our fertilizer forecast here) to reach the full potential of every acre of land. From the genetics to the production to the distribution companies, one could argue that continued innovation of this industry is vital to the future of agriculture.
In 2020, the commercial seed market alone reached an estimated $44.9 billion in annual revenue. With the global pressure on to produce, the world can no longer afford to have underperforming years of production, placing even more pressure on this sub-sector of agriculture to continue to develop treatments on both the organic and GMO sides (watch The Future of Feeding the World Podcast here).
Source: IHS Markit – @2021 IHS Markit
EQUIPMENT
With the growing demand for food-producing land due to the world’s growing population, advances in technology have seamlessly made the farming process more efficient, profitable, and undoubtfully safer. Modern farms and agriculture equipment have significantly evolved by incorporating sophisticated technologies like sensors and GPS to driverless equipment with new autonomous machinery.
These enhancements to heavy equipment are essential to farmers, allowing them to no longer apply certain things uniformly, like fertilizing or watering the field. But instead, farmers can use minimal effort to target specific areas of their fields. Let’s look at some of these added benefits due to technology:
Farmers have higher crop productivity.
There is a reduction in the overuse of water, fertilizer, and pesticides.
The price of food production is at a lower rate due to less manual labor.
Improves the safety of farmworkers and machine operators due by incorporating the use of drones and various software. Check out this podcast with Dr. Steve Irwin on technical platforms here.
Groundwater and rivers are experiencing less runoff of chemicals.
Undoubtedly, innovation of this business sector will continue to evolve and play a major role in the necessary production increases ahead.
GRAIN PRODUCERS
One hundred fifty years ago, work was hard for grain producers, but the job was simple – till the land, plant the seed and let mother nature do her job. As time passed and our global population grew and the demand for our arable land has grown exponentially; all of which, leads to the grain producers of today having the most important job in the world.
The work of the few is to feed the many. Since the post-WWII era, the number of farms has steadily been reducing, placing even greater pressure on those in production areas to continue managing their operations, focusing on profit margins, and working the inherently volatile world of commodity prices.
Imagine a 5,000-acre farm producing trendline yield corn of 180 bushels per acre. Quick raw math based on today’s price per bushel of $6.00 puts gross revenue at 5.4 Million dollars. Noting the rapidly rising costs of inputs (seed and chemical), labor and energy prices, a return to August 2020 prices of $3 would be a massive hit and likely take down such an operation.
All of this is to say that today’s job requires greater collaboration with others in the business than ever before (see section below on intermediaries and risk management).
INTERMEDIARIES/RISK MANAGEMENT
Commodity markets are highly unique in that both end-users and physical producers of a product can proactively buy and sell their input and or production in an open market before being produced via a forward contract or hedge.
To hedge is to manage risk and, in most cases, lock in or protect the profits margins. As discussed above, grain production is a highly volatile business, just like the purchase side (see end-users and commercials below).
Through intermediaries and risk management experts, farmers and end-users gain timely market information, access to markets, and ultimately execute the majority of their forward pricing. Whether through the use of futures, options, swaps, or even physical contracts developing and coordinating a risk management plan is essential to the long-term health of our global commodity infrastructure.
The CME Group is the world-leading commodity exchange, and their global branding says it best – “CME Group, where the world comes to manage risk.”
RCM Ag Services also falls into this category. We provide full-service risk management and advisory solutions to our local area producers and commercial agriculture operations around the globe.
TRANSPORTATION/LOGISTICS
COVID introduced unexpected stresses on global food systems, creating many immediate and rapid challenges to secure food availability. If a worldwide pandemic taught us anything, we know that supply chain management and transportation play a vital role within the agriculture industry. Agriculture logistics ensure that items like food, machinery, and livestock from all over the world are transported with a continuous, optimal flow from the manufacturers and suppliers to the producers and ultimately delivered to consumers.
Some of the most imperative agriculture supply chain and logistics management activities include production, acquisition, storage, handling, transportation, and distribution. Effective logistics is critical for guaranteeing customer satisfaction and meeting demands on time with high-quality products. In addition, logistics should also meet specific standards and operational objectives for efficiency in agriculture policies like:
Protection of the environment
Sustainable distribution practices
Food safety and security
Animal welfare (for transporting livestock)
With the growing population largely expected in developing countries, most of which have poor infrastructure, we can expect the need for massive investments into transportation and logistics operations in the years ahead (this is NOT a stock tip!).
COMMERCIAL AND END USERS
The penultimate step of the process is grain reaching a commercial elevator before going on to the end-user to be converted to a final product. Some producers deliver straight to the end-user in areas where that is an option.
Traditionally, commercial elevators accept farmers’ grain and then ship it to the end-user, either by rail, barge, or other means.
With the continued upward trends of production, it is no surprise, that grain storage capacity has consistently grown. In fact, it is on pace with increases in crop production over the last 20 years and by all accounts is likely to continue to grow.
Source: Farmdocdaily
Along with the enormous capacity, commercials and end users also carry a tremendous amount of of price / volatility risk requiring a proactive and disciplined risk management approach to maximize the margins of their operation and keep the system moving forward.
In 2018, $139.6 billion worth of American agricultural products were exported worldwide, with elevators playing a significant role in that process. The commercials and end-users are essential for getting the product from the farm into your home on the table.
FEEDING THE WORLD IN THE FUTURE
Bringing awareness to how the agriculture industry is vital to feeding the rapidly growing world is pivotal as we continue to face unprecedented challenges in global food security. However, there is a silver lining. We already know what must be done; it is figuring out how to do it that could be problematic. The world must unite and understand that each of these areas highlighted in the infographic is very complex, employs millions of people worldwide, and is vital to the growth of the agriculture industry as well as producing the necessary food for the future.
Download the Infographic
CONTACT AN AG SPECIALIST TODAY
Whether you’re a producer, end-user, commercial operator, RCM AG Services helps protect revenues and control costs through its suite of hedging tools and network of buyers/sellers — Contact us today to speak with an ag specialist at 888-875-2110!
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