With harvest just weeks away, it's not too early to ask the most important question in marketing grain after harvest: To store or not to store?
How do we answer this question? We start with a solid understanding of carrying charges in the market. Carrying charges are the price differences between futures delivery months (e.g. March and July corn futures, or November and May soybean futures). The concept of carrying charges is important enough to warrant several columns.
This month I will talk about how carrying charges (or lack thereof) send market signals to store grain, and what they tell us about the bullish or bearish tone of a market. Next month I will consider measures of carrying charges to gauge a large or small carrying charge. Finally, I will introduce you to Earl Eitheror, a celebrity producer who relies on his definition of a large carrying charge to write a simple-but-effective postharvest marketing plan.
THE CHARTS SHOW carrying charges in the corn and soybean markets as of mid-July. The corn market shows a positive carrying charge market, where deferred prices (March, May, July, etc.) are trading at premium to the nearby contract. The soybean market is partially inverted (aka negative carrying charges) — the nearby August contract is trading at a premium to the September and November contracts.
The price structure in both markets can be puzzling. After all, each contract delivery month represents the same grade of corn or soybeans. Delivery terms are also the same — why not the same price?
Contrary to popular belief, these price differences are not the result of expectations in the market. In storable commodities like grains, these differences reflect market-determined storage costs, better known as carrying charges. Positive carrying charges (see the corn market) are common when free supplies are large. We associate large grain supplies with bear markets and lower prices. Large grain supplies are a result of a bumper crop, poor demand or a combination of both.
Positive carrying charges reflect a collective sentiment that the market does not need grain today. They offer an incentive to anyone with storage facilities (your local elevator, merchandisers, exporters, processors, farmers) to hold grain off the market and sell a higher price for later delivery. By holding the grain in storage and selling at a premium price for later delivery, the market rewards them for their ownership of storage.
Here is my rule of thumb concerning carrying charges and grain supplies:
large grain supplies = large carrying charges and lower prices
WHAT ABOUT NEGATIVE carrying charges (see soybeans)? This type of market is saying, “We will pay a premium if you deliver now.” An inverted market occurs when supplies are scarce. Scarce supplies set the stage for bull markets and higher prices. Grain supplies become scarce when we have a poor harvest, strong demand or a combination of both.
Our rule of thumb must have a corollary:
small grain supplies = small carrying charges (or inverses) and higher prices
Do you see that 19¢ carry in the corn markets from December 2008 to March 2009 contracts? How about that 10¢ inverse from September 2008 to November 2008 soybean contracts? A simple measure but so much information; carrying charges offer a guide to storage decisions and a quick look into a bullish or bearish market.
Ed Usset is a grain marketing specialist for the University of Minnesota Center for Farm Financial Management (CFFM). He can be reached at email@example.com.