February 3, 2020
As you progress through a marketing year, it is critically important to ask yourself the hard questions to determine if you are really, truly managing risk to protect your bottom line -- or just wishing and hoping for a certain marketing scenario to come along. What are some of those ‘being honest with yourself’ questions?
1. If you were required to report to a board of directors, could you defend your marketing plan?
Let’s assume cost of production & break-even prices are known. If your plan is to wait and do nothing until prices move above your break-even price, how much will be sold above that level? Would it be 25% of expected production? 50%? 75%? How will the remaining unsold bushels be defended?
What is Plan B if those selling targets are not reached and much lower prices are in store?
Just imagine, if you will, a risk management team for John Deere or Caterpillar, with the responsibility of managing raw material inputs. If their plan was to simply wait (unprotected) for input prices to drop to a certain level, would the board of directors find that acceptable risk management?!
As a professional in ag production, you need to be thinking in terms of putting yourself in a position where you can honestly be able to defend your marketing plan to the board – even if prices don’t move significantly higher.
2. Do you still have price risk below break-even?
Does the market have any concern whatsoever that prices are below your cost of production? I believe you already know the answer to that one.
While knowing your break-even is vitally important, why should anyone assume prices have to move above that level? Price still needs to be defended (not necessarily sold) even if prices are below your cost of production.
For example, if your break-even is $3.90 and you can purchase December 3.90 puts for 17 cents/bu., that provides a floor of 3.73 before fees, futures carries, and basis. If prices would move significantly higher to $5.50, for example, you’d still be able to sell those physical bushels at the much-improved price level.
Hands down - that’s the best outcome – a loss in the hedge account, but a much larger gain in the value of the physical commodity! However, what if final export numbers continue to shrink, U.S. farmers plant 94-plus million acres this spring, and an above-trend yield is realized? Having a $3.73 floor, while still below break-even, would be far better than having the wind knocked out of you with a plunge to $3 per bu. and no protection in place. Having a small loss compared to a huge loss could be what sets you apart from everyone else!
3. Do you always cheer for higher prices in your marketing plan?
If you don’t, it indicates that something is terribly wrong in your marketing plan. Grain producers are almost always long multiple years of production.
First, there are unsold bushels in the bin from the ’19 crop (and maybe even a little carried over from ’18 crop), then there’s the unproduced ’20 crop that’s still in the seed bags, and finally, the ’21 crop in the rotation.
Higher output prices, in general, are best for the bottom line. So why would you or any grain producer not enjoy the experience of higher prices? If you have attempted the basic scale-in selling method- 15% at $3.85, 15% at $4.00, 15% at $4.15 per bu. -- and then a major price rally ensues after that, it likely doesn’t feel so good. Why is this market going up!?!
If this question is being posed, there’s a really good chance it is because the upside was not respected. It can happen so easily to anyone as you sell more and more at what feels like higher levels, but they end up being toward the lower end.
As prices continue higher, you lock up and miss out on the much higher prices, before prices eventually come crashing down. How can control be retained? Consistently purchasing call options at the time of making the sale keeps you rooting for higher prices. It also gives you the confidence to pull the trigger, as you can still participate and benefit from the call gaining in value if prices continue to rally to much higher levels.
Let’s face it. No one has an inside secret as to which direction futures prices will move, how high or low they’ll travel, or when it will all happen. One thing is certain though, prices don’t move one direction forever and, when it goes the other way, it can be very unexpected, sharp and painful. Employing a disciplined, consistent, and flexible plan will allow you to adjust to capitalize and ultimately produce much better results, over the long haul, than a rigid, emotional, and price-forecasting approach. Being open, honest and transparent with yourself, and asking the hard questions, can help move you in the right direction of truly defending your bottom line in today’s uncertain marketing environment.
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