The reality of deficit supply in regions of the U.S. has fueled cash traders to compete for inventory at record basis bids. Reports this week of commercial bean purchases at $1 to $1.25 over CME price at locations like Kansas City, St Louis and Quincy and Gilman, Illinois; when posted bids were in the 40 to 65 over CME futures got the engines running.
The thought of beans headed towards one river house getting diverted on truck to a processing plant, leaving the Gulf short of previously expected delivery was like pouring rocket fuel into the morning coffee of futures traders.
We stated on several occasions last fall that 2021 could be a career-making market. This has been one of the best weeks we have had for our clients at AgMarket.Net. Since last fall, we recommended our clients replace every bushel sold with call option strategies that have captured the bulk of this move and now we are selling additional cash at sweet premiums and buying more calls. About three months ago, we mentioned the risk of a potential squeeze play in July. Now it looks like the market is using the May deliveries to prepare for the July deficit.
- Cash markets are getting to a premium that will divert supplies away from deliverable position. Currently there are only five contracts, or 25,000 bushels, in a deliverable position located at Hennepin, Illinois, out of 40 certified deliverable houses.
- Processors are long 305,000 contracts of soybeans while reportable traders are short 101,000. This leaves about 200,000 short positions that are held by other cash merchants hedged against inventory or spreaders and/or non reportable traders, which are small accounts.
- Usage continues to exceed USDA's projections. The implication of this is that at current rate of use, carryover will be smaller than the 120 million bushels USDA is representing in their supply demand table. Industry estimates 120 million is the pipeline requirement to keep the industry fluid. Thus, any carryover below 120 million creates a deficit that would require imports or rationing.
The math behind the saying
End users need to secure summer inventories to keep plants running. Exporters also need inventory to meet commitments on sales made. With cash markets trading $1.00 over CME, there is a possibility that end users may use the deliverable process at the CME to obtain ownership at board price. Obviously, there are fees and loadout costs associated with taking delivery, but even if that accumulates to $0.40, that is a lot cheaper than paying $1.00 to $1.50 over CME price to buy beans in the countryside.
In a year where supplies are tight, the main commercials of our industry would require producers who've made contracts to sell beans to deliver those beans per their contract. Same is true for a trader who sells a futures contract, they also made a commitment to possibly deliver those beans per the specifications of the futures contract. Where would that speculator obtain inventory to deliver?
Stocks in deliverables positions are no higher than they were a year ago when we continued to see a very strong cash market. This year not only are end users battling for these bushels, but also there is a real and present threat that if weather turns sour, there will be little to buy for 2021-22. This means getting some extra inventory bought might be a very smart idea for users until they see the June Acreage report and the July-August weather forecast. This threat should keep the cash market very strong.
A speculator trying to find delivery of cheap inventory will not have a chance to be successful when competing against professional cash traders. If the speculator cannot buy cash inventory at a reasonable price, register certificates and deliver those certificates to the CME to meet their short obligations, then the short speculative position that needs to offset their obligation only has one choice---"Pay the Price or go to Prisn’ --- and buy back their short futures at wherever the owner of those futures contracts is willing to sell. Since the processors are the ones that are long, why would they be willing to sell futures at anything less than the going cash market? Based on today's market that would be approximately $1.00 higher.
The futures market was initially intended for the agricultural industry to manage risk. The situation I describe above is called forced convergence. This is why the CME has the deliverables process. The deliverables process keeps the futures market honest to the real market value or the cash market. Without this check and balance, speculators would be able to manipulate futures to whatever price they wanted regardless of where cash is trading. This process forces the futures to fairly represent cash values.
This might not end well
Although the CME contracts are well-written to force futures to always represent cash values at deliverables points, the CFTC and CME also have an obligation to provide an “orderly market.” So how do they do that in an environment like we see going into the May and probably July delivery process?
They could do nothing and just let the market converge on its own free will. But history tells us that's not what will happen. In my 40-year career, I have been involved with many situations where forced convergence is taking place. The most likely situation will be the exchange will privately ask large accounts to liquidate positions and/or roll them out. Their rationale would be that if you want to own, then own a July or August which are cheaper than the premium the May contract holds. If they are not willing to move to a cheaper contract, the CME could ask for proof that the participant has an economic need to take delivery. The next likely thing they will do is raise margin requirements. They could set margin deposits at 100% of contract value. This, of course, would cause most accounts to liquidate their positions. The last resort that the exchange would take is to impose a liquidation order only. This, however, will probably not come directly from the CME, but most likely from clearing firms who receive a friendly phone call from the CME asking them to impose this order. In one instance that I personally know of, the exchange called the remaining participants into a room and moderated a cash delivery settlement of the contracts. But that will not happen in soybeans.
Will that be the end of our market?
It is possible the bull market move may be done after this process occurs. But we believe that will depend on the June acreage report and summer weather. Seeing a high in soybeans at $15 plus per bushels is in line with historical tops in the $15 to $18 range. However, with this year's world stocks-to-use ratios and the obvious 2% stocks-to-use ratio in the United States, the marketplace has never seen a situation quite like this. Therefore, if yields are struggling and will be below trend, it is very likely new historical highs will be reached. If we have great weather, then we might be headed lower.
We welcome your phone calls to discuss the market and provide sound advice based on the profitability of your operation. The old timers (I guess I'm one of those) had pretty wise sayings for many situations. A speculator who “Sells something that Isn’t Hisnt;'" at a price that is well below the cost of buying that product puts himself in a situation where he cannot deliver profitably and the only way out of that obligation is to “Pay the Price or go to Prisn’.“