Common Mistakes in Post Harvest Marketing

By Ed Usset
usset001@umn.edu  

With another harvest looming, I can sense the frustration of producers once again facing the dreaded questions of what to store and when to sell.

I think the frustration for many is the result of taking a misguided approach to marketing.  Too many producers pursue what I call the “two-step” approach to marketing: 1) try to figure out which direction grain prices are headed; 2) then sell some grain. But this process overlooks one important point: It’s hard to predict prices! 

I’ve lost count of the times I have heard an “expert” offer a well-reasoned opinion on market direction, only to be proven remarkably wrong in the months ahead (One wag recently suggested that the analyst still holding out for $18 beans was simply honing the skills he learned earlier as a CIA weapons analyst).  The difficult task of predicting market direction is accentuated by producers’ natural tendency to hear only the good news in the latest outlook and wait – always wait – for the better prices that are surely just ahead.

Let me suggest to you a different approach to marketing. Instead of making marketing decisions based on your market opinion, you might make more progress by focusing your attention instead on eliminating mistakes?

What is my idea of post-harvest marketing mistakes?  One mistake is the general misunderstanding of carrying charges in the market, and what it tells us about the opportunity to store grain. Another is the lack of an exit strategy.  And there are always producers who hold grain in storage too long. 

You may be skeptical that simply eliminating a few mistakes has the potential to assure success. But I like to remind producers that marketing strategies which increase net price received by just 10 cents per bushel can increase net income by 33-50%. We don’t necessarily need complicated trading strategies to get there. We can get there by eliminating mistakes.

Common Marketing Mistake: Misunderstanding the Role of Carrying Charges in the Market
Not many producers have a clear understanding of carrying charges in the market.  Carrying charges are the price difference between futures prices of the same commodity in different delivery months (e.g. the difference between December and March wheat futures, May and September corn futures, etc.).  These spreads between different delivery months speak directly to the incentive to store grain, more so than even the price of the commodity. Carrying charges are freely determined in the market, constantly sending signals and incentives to market participants to sell grain now or to store grain for delivery later in the year.

For purposes of illustration, let’s look at the corn market, where carrying charges are common.  As of mid-summer, the July 2005 corn contract is trading 17 cents higher than the December 2004 contract – what the market would call a 17-cent positive carrying charge.

Positive carrying charges are common when free supplies of grain are large (think big crops). Grain merchandisers, processors and exporters are all hedgers – they hedge their cash price risks with offsetting futures positions. A positive carrying charge is an incentive for them to buy today’s lower price, store the grain and sell tomorrow’s higher price. This is called “selling the carry,” and producers can do it too using forward contracts, futures fixed contracts, or by selling futures directly.

To fully understand carrying charges, it is helpful to consider the inverted market, where the nearby contracts trade at a premium to deferred contracts. Inverted markets prevail when supplies are small - a scarcity of stocks.  The premium is for delivery today as the market offers no incentive to carry stocks for later sale.  For an example of an inverted market, we need to look no further than soybeans. Following last year’s smaller crop, the soybean market has since displayed sizable inverses throughout the past year.

Carrying charges are so fundamental to the issue of storage, that the first question I ask myself before deciding my post harvest marketing approach for the year is “What’s the carry?”  For a sense of what represents a large carry, I like to track carrying charges at harvest time - the September/March spread in spring wheat futures in mid-August, and the December/July and November/July spreads in corn and beans as of mid-October.

Since 1984, the September/March wheat carry has averaged 14 cents per bushel and ranged from 2 cents in 2002 to 31 cents in 2000.  Over this same period, December/July corn carry has averaged 17 cents per bushel, while November/July beans averaged 23 cents per bushel.  The carry in beans has ranged widely in recent years, from a 36-cent positive carry in 2000, to an 82-cent inverse last year.

How would I use the carry? If carrying charges are larger than average and I have on-farm storage, I want to sell the carry with a forward or futures fixed contract.  How much grain I price depends on my storage capacity and the size of the carry. If carrying charges are small (or inverted), selling the carry simply won’t work, and I will consider holding my grain unpriced in the bin, or selling the grain and replacing the ownership with call options (not my favorite strategy – see “The Case Against Options” in last year’s marketing issue, online at www.smallgrains.org/springwh/MGuide03/case/case.htm).

Common Marketing Mistake: Lack of an Exit Strategy
Over the past few years I’ve asked producers to select their own marketing mistakes from a group of five (others on the list not discussed in this article: the reluctance towards pre-harvest pricing, and failure to understand and track your local basis). Since this mistake is often at the top of the list, I challenge producers to understand what an exit strategy is, and why the lack of one is a marketing mistake.

Consider two basic post-harvest marketing strategies: 1) Hold your unpriced grain in storage or 2) Sell your grain and buy call options.  These are very common strategies used by producers to position themselves for a post-harvest rally in cash or futures prices.  For producers who argue the merits of these strategies, I tell them that they have only constructed half of a strategy.  The other half is when you get out or, as I like to ask people, “What is your exit strategy?”

These strategies position the producer to profit from a post-harvest rally.  But I challenge producers to put a number on the size of a market rally that will satisfy them. Are you looking for 20 cents more or $1.00 more? What if the market moves lower - when will you cut your loss? Without a defined exit strategy, the producer is left to trying to pick the high. 

We’ve already discussed the producers’ natural tendency to wait for the better prices that are surely just ahead.  “The market has rallied 35 cents in the past two months – I’ll wait for another 20 cents, then sell.”  Sound familiar?  So might this one: “The market has declined 15 cents - I’ll wait to sell when the market gives me back the 15 cents.”  You can see that without an exit strategy, emotions can easily guide your decisions.

Let me suggest two simple types of exit strategies, one driven by price, the other by time. A price-driven exit strategy is where you set a specific price objective, such as selling grain in storage at a price 30 cents over your harvest price. Or maybe it’s a specific amount above your break-even, or a number per acre. Conversely, you must define your maximum loss should prices fall below your harvest price. 

With a timing-based exit strategy, you let time determine your way out.  For example, you could sell grain in regular intervals over a particular time period (i.e. one truck per week over a ten-week period, or when prices are traditionally at their seasonal highs). You could even incorporate your favorite technical price analysis tool by choosing to sell when prices signal (moving average, support point, trend line) a change in the trend from up to down.

Price and timing strategies are far from perfect, and they are certainly no guarantee of selling at the best price. But either one beats relying on your emotionally clouded judgment of the moment.  I recommend you define your exit strategy at harvest, then stick to it!

Common Marketing Mistake: Holding grain in storage too long
Many producers have ample grain storage capacity on their farm.  Used properly, storage can be a powerful tool that allows producers to speed their harvest progress and avoid seasonal pricing lows.  But for too many farmers, storage is a tool for carrying last year’s marketing problems into the next year (and sometimes the year after that). To understand the perils of holding grain in storage too long, it is critical to review basis patterns.

Basis patterns in grains and soybeans have some strong seasonal tendencies.  Basis -- the cash price relative to the futures price -- is weakest at harvest and strongest in the spring. In the latter half of the marketing year, usually in early to mid-summer, basis levels start the transition back from spring highs to their harvest lows. This adjustment in the basis is silent but powerful.

During this time our attention is focused on futures prices – will they go sideways, higher or lower? But the trend in basis is down.  Basis declines of 20-40 cents per bushel are normal in the last few months of the crop year, and with the basis decline, so goes the cash price.  Only in those years when futures prices rise more than the erosion in the basis can you profit from holding grain in the bin. The trend is so strong and risks so great, that I like to quote the “11th Commandment” of grain marketing – Thou Shall not Hold Unpriced Cash Corn or Wheat in the Bin Beyond July 1 (August 1 for Soybeans).

The 11th Commandment speaks to the annual transition from old crop to new. This price adjustment occurs a number of different ways. Some years the futures market trades sideways while the basis slowly erodes over the summer months – cash prices are gradually dragged lower into the new crop.  Then there was this summer and the soybean market: Over a ten day period in the first half of July, a swift drop in both the nearby futures contract and the basis combined to take over $2.00 out of the cash price of beans!

If there were just one mistake that I could prevent from making, holding grain in storage too long is the one. The odds for success in making this mistake are poor. For me, the 11th Commandment is really the ultimate exit strategy. Regardless of your successes or failures in marketing your crop after harvest, July 1 is time to empty your bins and refocus your efforts on marketing the crop in the field.

So there you have it – common post harvest marketing mistakes. Recognize them, and work to avoid them this harvest. What are the carrying charges telling you about the opportunity to store grain and sell the carry? Have you defined your exit strategy with price or time-based selling objectives? Finally, remember the 11th Commandment.  Don’t hold unpriced cash corn or wheat in the bin beyond July 1, or soybeans beyond August 1.

Usset is grain marketing specialist for the University of Minnesota’s Center for Farm Financial Management (http://www.cffm.umn.edu ) developer of FINPACK and MARKETEER software. Working with his colleagues at CFFM and in Extension, Usset has helped develop the award-winning “Winning the Game” series of workshops.  The third and latest of this series, “The Post Harvest Marketing Challenge,”will be available for local sponsorship and scheduling this fall. To learn how you can become a sponsor, call CFFM at 800-234-1111.