Should wheat producers store for higher prices?

Should wheat producers store for higher prices?

Wheat producers should know market risks. Only store wheat when you can afford lower prices. Cash wheat prices have declined from $8 in late January to about $6.80.

“Kim, long story short: I have a customer that has a large loan on his farm with annual payments that are due right now. Payments depend on the sale of crops.  He has all his wheat cut and in storage.  He tells me he wants to wait to see if the price goes up as harvest moves north into Kansas.  You are the expert, if he holds off a couple weeks what is the likelihood that the price will increase on his stored wheat?  I would like the payments to be made simply because they will be past due.  Can you give me your opinion on this?”

How would you answer this email? The following is my answer.

“In an efficient market, and the wheat market is mostly efficient, the odds of wheat prices going up are 50/50. However, wheat prices have been on a downtrend since the first of February. Wheat production continues to come in slightly higher than expected. 2013 corn conditions continue to improve, which implies relatively large U.S. corn production. The Oklahoma wheat basis is about 40 cents above average. World wheat production is projected to be record or near record. All these factors have negative implications for price. Therefore, it is my opinion that over the next few weeks we have a 65 percent chance that wheat prices will decline compared to a 35 percent chance that they will increase.

My philosophy is: ‘If you can’t afford to sell wheat for $6.25, you had better sell it now for $6.65.’ Or put another way, ‘which is going to hurt you worse, not selling wheat for $6.65 and having to sell it for $6.25 or selling it for $6.65 and not having the opportunity to sell it for $7.25?’

The question is not ‘what are wheat prices going to do?’ It is, ‘what risk can you afford to take?’ My suggestion to producers has been to sell 50 percent of their production now and sell the last 50 percent in Sept/Oct and Nov/Dec.”

Cash wheat prices have declined from $8 in late January to about $6.80 at this writing (note about 15 cents above when I replied to the email). Since last January, the KC Red Wheat September wheat contract price has declined from $8.72 to $6.91. The cash price declined about $1.40, while futures prices declined $1.81. The KC September basis increased 41 cents.

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Corn stocks are extremely tight, which has resulted in relatively strong feed demand for wheat. If and when a 13.7 billion-bushel corn crop is harvested, the feed market will no longer need wheat for feed, and the wheat basis will probably decline to normal levels. This possibility implies about a 40-cent decline in cash prices due to a declining basis.

To store wheat in commercial storage costs about 6 cents per bushels per month (4 cents storage and 2 cents interest). Total costs to store wheat until December 1 is about 30 cents per bushel.

If the basis trends back to normal (40 cents) and storage and interest costs are 30 cents, the KC December wheat contract price will have to increase 70 cents just to keep the net price equal to the current price. An alternative to storing wheat is to sell all the wheat and replace all or part of the wheat with KC December wheat call option contracts.

“At-the-money” KC December wheat call option premiums are about 40 cents per bushel or $2,000 per 5,000 bushels contract. Of the 40 cents, 30 cents would be paid for by not paying the 30-cent storage and interest.  If prices decline, the net loss would be $500 per 5,000 bushels or 10 cents per bushel.

No perfect decisions are possible because price movements can’t be predicted. Managers should have written plans and the discipline to follow the plan. Only store wheat when you can afford lower prices.


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