Issue 31
Marketing Guide 2000
 

Prairie Grains is the official publication of the Minnesota Association of Wheat Growers, North Dakota Grain Growers Association, South Dakota Wheat, Inc. and the Minnesota Barley Growers Association.

Copyright
Prairie Grains Marketing Guide 2000

A give and take marketing strategy

Take what they'll give you." It's an old sports analogy, but it certainly could apply to today's wheat market as well.

What the market is "giving" currently is a premium for selling wheat in the future. In fact, over the past three years of declining prices, the market for wheat delivered in the future has been consistently higher than the price for immediate delivery.

But it hasn't paid to simply store wheat and wait for higher prices to arrive. To make the extra 25 to 30 cents per bushel, a farmer would have had to sell several months in advance to lock in the premium. If he didn't, the premium disappeared every year as prices continued to slip (see chart of March futures).

MGE March Spring Wheat Average Daily Closing Price 1997-2000
$/Bu

This premium paid for future delivery is called a "market carry." A market carry is present when the price of the nearest futures month is less than the price of contracts into the future (see example). This premium partially covers the cost of storage and interest to "carry" the wheat into a future month, and it currently presents an opportunity to sell cash grain for a higher price than can be received by simply selling off the combine.

Mike Kvistad, grain market analyst with Benson Quinn Commodities, said capturing market carry has been an extremely successful strategy in recent years. Because prices are typically lowest at harvest, Kvistad advises farmers to take the LDP at this point. Since the LDP has an inverse relationship to the price of wheat, a farmer often captures an LDP near its highest point.

As of early August, the average LDP for spring wheat in North Dakota was 70 cents per bushel. When added to the March futures price on August 3, that's nearly $4.00 wheat.

So how is market carry captured? Kvistad said when a farmer takes the LDP, he immediately takes possession of his cash wheat. At that point, he must hedge that position, or risk holding wheat in what has been a bear market. He said selling futures or forward contracting are two ways to capture the nearly 30-cent-per-bushel premium currently offered.

By completing this strategy, Kvistad said there are several benefits for the farmer:

1. An LDP is captured that is typically near the highest of the year.
2. The stored wheat is protected from further price declines should the three-year bear market continue.
3. A significant price premium is captured, especially if the farmer has on-farm storage.
4. If futures are used, the farmer has the opportunity to benefit from any gains in the local basis. Historically, the basis (the difference between cash prices and futures) will strengthen following harvest.

In addition, Kvistad points out that an out-of-the-money call option can be purchased to give the farmer the opportunity to benefit if a significant rally should occur.

All in all, this strategy is more take than give. It requires a farmer to take action now, rather than waiting for the market to give down the road.

Calculating market carry
The examples below are actual MGE futures contract prices on the first trading day of August. The "market carry" column illustrates the premium for the March contract over the September contract.

Year MGE Sep Contract MGE Mar Contract Market Carry 1998 3.08 4.25 0.17 1999 3.43 3.69 0.26 2000 2.97 3.29 0.32

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Strategy Examples

The following scenarios use actual numbers from 1999 to illustrate the results of three different strategies. The LDP used is the average LDP for North Dakota on August 4. The price is that of the March futures on the first trading day of March.

1. Take LDP at harvest, store wheat, sell March futures, deliver March 1.

LDP collected      .36 cents
Contracted price 3.69
Final price        $4.05

2. Take LDP at harvest, immediately sell wheat.

LDP collected  .      36 cents
Contracted price   3.43
Final price          $3.79

3. Take LDP at harvest, store wheat, deliver March 1.

LDP collected  .    36 cents
Delivered price  3.11
Final price        $3.47

4. Put wheat in loan, take LDP March 1 and sell cash grain.

LDP collected  .  21 cents
Delivered price  3.11
Final price      $3.32

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Recent results

Over the past two years, it has paid to price wheat ahead at harvest rather than storing without any price protection. Forward contracting or selling futures can accomplish this. The example below uses the March MGE hard red spring futures contract on the first trading day of March.

Year Nearby Price August March Futures Aug1 Nearby Price Mar1 Gain/Loss From Storage Only Gain?Loss From Storage & Selling Futures 1998 3.08 3.25 3.16 0.08 0.17 1999 3.43 3.69 3.11 -0.32 0.26