Have a strategy when commodity markets go against your position to buy or sell crops
Wild commodity price swings are reacting to drought conditions that are leaving some farm producers wondering what they could have done to protect their situation.
Many farms may have done some early commodity marketing by taking a contract to deliver a portion of the 2012 production this fall. Farm producers have a wide variety of delivery or contracting alternatives available to them. It is now extremely important to know what you’re responsible to do, to comply with the marketing contacts already in place. Be sure you have read the entire contract and understand your responsibilities as the commodity producer.
As the total potential production for this summer shrinks due to the drought taking its toll on crops still in the field, the total production of most grain commodities will be impacted. Some commodity delivery contracts are written to require the farm producer to deliver the required bushels of crops even if it means they have to purchase the commodity on the open market and pay to have it delivered. If you think you may fall short in producing enough to fill your delivery contract, start the conversation early with the contract holder so neither of you is caught by surprise when the contract delivery date arrives. By working with your contract holder you may be able to develop alternatives to fulfill your obligations.
Farm producers that used a delivery agreement may have locked in the price at a level that is, or could be lower than what the current cash market is. Now you are wishing you could still be in the market to capture some of the higher cash prices as the market rallies. The use of an option – put or call contract – could be a tool to allow a farm producer to cover some of the negative impacts of major potential price swings. With option contracts, you are placing a minimum or a maximum price guarantee with either a put or call contract. In a time when markets have the potential for huge price swings, farm producers may find the use of an option contract as a good price risk tool. In weather driven market like we have today, some farms may find the use of a put option as a useful tool to place a floor under some of these very high prices to insure against them falling later this season. Other farms may want to use a call option to place a maximum price on feed grains to protect against additional price increases in future months. A key with using these types of market tools is having a commodity trading account established in advance.
Setting up a commodity marketing account will require a few dollars and some time on each farm’s part, but it’s worth it to be able to have full access to use these tools to manage price risk. It can have huge impacts on your farm’s profitability. Not having a full set of marketing alternatives puts you on the side lines. Then as commodity prices rally higher or as they fall back to historical prices levels, you are unable to catch the profits such price swings create. When the market gets really hot, local cash markets may shut down some of their marketing services just when you need them the most.
Many have commented that one of the better marketing strategies the past couple years has been to sit on the sidelines and avoid forward marketing contracts. However, good marketing practices will help manage risk. Thus it is still considered a good management practice to take the time to build a marketing plan for your farm. Be sure you go over the plan with your farm’s management team and marketing advisors to gather additional points of view and input. Then put in place written strategies to allow your farm to reach the financial goals that have been identified. It is clear this is a volatile commodity market and the upward trends have been in place for some time. This leaves farms only to wonder when the current price trend will reverse and head lower.
- MSU Extension’s Drought Resources