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By Jose G. Peña Price bids for most major agricultural commodities continue to improve and the market outlook appears encouraging, but markets could weaken. Corn is trading at near life-of-contract highs, cotton markets are slightly above last week's lows, futures price bids for cattle appear to have recovered all of the "mad cow" disease-induced market decline, and even poultry is trading at record high prices. Recent improvements in the live cattle market appear to have been influenced by Mexico reopening its borders to U.S. beef exports. While no one can accurately predict the market with a high degree of certainty, it appears that price bids are near the top in relation to the latest supply/demand information and may be starting to trade sideways, especially for corn and cotton. Producers should seriously consider establishing some price base protection, either through cash forward contracts or with a selective hedging mode in the futures market. The recent market improvement appears export-driven, especially for corn and cotton. Export-driven markets tend to be more erratic, thereby increasing the price risk for producers, merchants, cooperatives and everyone who owns or uses a commodity in their trade or business. Futures price bids for corn dropped slightly on Tuesday, March 16, when this report was prepared, after reaching life of contract highs of around $3-$3.09 per bushel for most 2004 futures contracts on the board, indicating sideways trading. Futures price bids for most 2004 cotton contracts reached life-of-contract highs last October, weakened, strengthened, and now appear to be trading sideways in the 65 to 67-cent range. As corn, sorghum and cotton planting gains momentum, farmers are encouraged to consider implementing some price base risk management protection for their cash price. Direct payments will help income, but it appears doubtful that farm program counter-cyclical payments will be significant, except maybe for cotton. This market rally will probably attract most market traders to sell contracts in an attempt to capture potential profits from downward movement. In terms of corn, world supplies are tight and increased demand appears to be fueling this market rally. Futures price bids could weaken as demand works through the record large 10.114 billion-bushel U.S. corn crop. The cotton market appears even more vulnerable, since almost 76 percent of the 2003/04 crop is export-bound and U.S. cotton exports account for more than a 60 percent share of the world cotton export trade. Recent market improvement could spark increased corn, sorghum and soybean plantings and, depending on weather, could increase production and carry-over stocks in the 2004/05 season. Plantings and weather conditions in major producing areas this spring and summer will play a critical role in the direction of agricultural markets. The market is already anticipating increased production as futures price bids for the new crop show weakness, compared to price bids for the old crop. The first survey-based planting intentions report for spring-planted crops will be released on March 31 by USDA and will be critical to market direction. Ending stocks for most crops are estimated to be quite low for the 2003/04 season, and markets could become volatile by the start of the new harvest if yield estimates, as the new season progresses, vary too far above or below trend yields. Meanwhile, after weeks of planting delays this spring due to wet fields in Texas, dry, mild weather this past week allowed some producers to finish planting corn and sorghum. Late plantings are causing concerns for increased production risk if dry weather returns, as was the case from November through early March, and temperatures rise early this spring as they did two years ago. In addition, high energy prices will boost production costs sharply in 2004. Energy costs have increased 15-20 percent during the last few weeks and will cause an increase in all related input costs such as fertilizer, transportation, electricity, chemicals, etc. As a result, it becomes imperative to implement price risk management alternatives which will help protect cash prices and improve income. A risk management program should focus on the concept of revenue risk protection by forward pricing through hedging and/or forward contracts and the use of crop insurance to protect production. Producers should establish a price by going short [selling a contract(s)] in the futures market. Buying a PUT will establish a price floor at the strike price (less premium, commissions and the time value of money) while keeping upward price movement potential open. Keep in mind that as prices increase past the loan rate, counter-cyclical payments decrease by a like amount. In addition, CC payments only cover 85 percent of base yields. Production above the base yield is only protected to the loan rate with LOPs. As national average prices rise above that value, CC payments cease. While prices for most farm program commodities are already above the loan rate for the commodity, a CALL option [right to purchase a futures contract(s)] could be used to protect CC payments if prices are expected to rise but stay below the national price rate, which would eliminate a CC payment. At the current strike price, cotton appears to be the only commodity where a CALL option could save CC payments. This alternative becomes more critical when futures prices drop to 55 cents or below. Some would argue that since CC payments are settled at the end of the national marketing year for a particular season and commodity, which may be as much as 12-15 months after planting for South Texas, the time value of the money tied up in a CALL option may be higher than the value the CALL will protect. While this may be true, keep in mind that the producer would be protecting the cash value of the crop. Keep in mind as well that CALL options based on futures price bids for December or March would cover most of the price risk, since by then most of the new harvest is in and prices tend to stabilize. Cotton After dropping to the upper 20s during fall '01, price bids for cotton commodity futures contracts have been gradually showing strength and are now trading in the 65-67 cent range for 2004 contracts. A reduction in U.S. carry-over stocks from very high levels three seasons ago has probably influenced the market improvement. The world cotton situation is also bullish to the market, as world stocks have declined. While the "A" index weakened this past week and the Adjusted World Price, which is used to calculate loan deficiency payments, dropped about two cents to about 58 cents per pound, the "A" index and the AWP are still bumping the highs of the last three years. At harvest time for south Texas, the cash price for base loan quality cotton is usually six to seven cents below December futures. Currently, a simple strategy of using PUT options could set a floor cash price of about 50.5 cents, net of premium and expected basis (e.g. a 59 Put at a two-cent premium less average basis of about 6.5 cents). Some would argue that this transaction would be irrelevant since the farm bill protects to the loan rate of 52 cents per pound with the marketing loan program. While the protection is true, keep in mind that this transaction would protect a drop in the cash price. The marketing loan program would protect to the loan rate, but total revenue would be lower without this protection if local cash prices drop below the loan rate. This is especially relevant for the producer who plants cotton and is concerned about a severe drop in prices because of another large crop. There are other pricing strategies that may need to be considered, such as a window. |
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