Missouri economists say market sending signal with cash basis

The recent rise in the cash basis for soft red winter wheat at Mississippi River grain terminals may mean the market is trying to send a signal, a pair of University of Missouri agricultural economists say.

Earlier this week, Reps. Jo Ann Emerson, R-Mo., and Marion Berry, D-Ark., wrote a letter to the head of the Federal Trade Commission asking for an investigation of the widening of the wheat basis in their districts in southeast Missouri and northeast Arkansas.

Charles Kruse, the president of the Missouri Farm Bureau, also sent a letter to several grain buyers, asking them to explain why the cash basis is widening and why farmers aren’t receiving the same increases from local grain markets as from futures trading on the Chicago Board of Trade.

While they did not comment on the letters, the University of Missouri economists said the difference in CBOT soft red wheat futures and cash grain prices – which has reached as high as 46 cents in recent days – could be a signal for farmers to hold grain.

“When cash prices are low, the market is saying: ‘We have all of the grain we need right now, ’” said Melvin Brees, grain market analyst with the MU Food and Agricultural Policy Research Institute or FAPRI.

“Buyers bidding higher prices on the Chicago Board of Trade, meanwhile, are saying: ‘This grain may be worth more later because grain supplies are expected to tighten.’”

A high futures price offers to pay farmers to store grain until it is needed by the market, he said.

The difference between the local cash price and futures price is known in the grain trade as the “cash basis.” That difference represents grain handling costs, transportation, interest and supply-demand balances in the region served by the local elevator.

“The weak cash basis is a market signal saying, ‘Avoid cash sales,’” Brees said.

Abner Womack, co-director of FAPRI, said the positive side of the current market is that there is a strong signal to sell on the futures market instead of the local cash market.

Large carryover supplies from the 2004 and 2005 crops may also be limiting storage space at many grain elevators, forcing managers to delay additional purchases of grain, said Brees.

“The basis levels for corn and soybeans are weak, too,” he notes. “There are more than 2 billion bushels of corn, plus a record-setting supply of soybeans, after two large crop years. Winter wheat coming to market in July will be competing for elevator space now filled with corn and beans.”

Although the harvest-month futures price (July wheat futures) is higher than cash price, the distant months’ futures (September and December) offer even higher prices.

Those distant months’ higher futures prices are called “market carry” which offers to pay farmers to store, or carry, grain until it is needed by the market, Brees said.

“We’ve had a lot of speculative activity from hedge funds who think grains are under-priced. That tends to provide strength in futures. Some of that is also spillover from the Kansas City Board of Trade, which trades hard red winter wheat futures.

“The ending stock of hard red winter and spring wheat have been declining while stocks of soft red winter wheat, the class grown in the Mid-South and Midwest have remained fairly stable. The hard red winter wheat area is out west where the drought has been occurring.”

High futures prices could pay a farmer to build a bin to store wheat. “That’s something a producer must calculate carefully,” Brees added. “The futures price must also pay for the risk of holding a crop in storage.”

Cash basis can also be a signal for farmers to look for alternative markets, Brees said. “It is always a good idea for a farmer to look beyond the local elevator for a market. If the basis is 60 cents locally and only 30 cents at the nearest river terminal, that 30-cent difference can pay transportation costs to the river. A farmer with a truck can take advantage of the differential.”

There may be similar price differentials for corn at an ethanol plant or a feed mill for a swine operation.

“When any given user needs more grain, they increase cash offerings to pull in more grain. Price differentials in the market are just the market’s way of allocating grain to where it is needed. The market works.”

As an aside, Brees said large differences between futures prices and local cash prices may be a sign that the futures are too high.

“Local cash price may be a truer indication of the current demand for grain,” Brees said. “There is a lot of speculation built into the futures price.

“Traders bidding prices up are anticipating a future shortage of grain,” Brees said. “That may be because they think ethanol demand will increase sharply, or that exports to China will increase or that the weather will cause a short crop this year. Those are all unknowns.”

Rarely do futures price for wheat reach higher near harvest, Brees said. “Only twice in the last 20 years have harvest-time wheat prices topped $4.15 per bushel, the present prices offered on the Chicago Board of Trade.”

Futures markets provide a way to lock in a price that may not be there when harvest begins, Brees said.

FAPRI economists don’t necessarily recommend that wheat producers sell futures contracts to cover their potential wheat harvest.

“Selling futures contracts is a higher cost, riskier strategy,” Womack said. “A less costly way to ensure a price is with options.” Buying “calls” and selling “puts,” or options to trade later, allows producers to bracket an acceptable price for their grain.

FAPRI urges producers to sell their crop in increments when the market price covers their cost of production, and offers an acceptable profit.

Trading in futures commodities should be done only after studying potential profits – and losses, Womack said. Also, producers should have grain, or potential to harvest grain, before selling futures contracts. Trading without holding grain goes from making a hedge, which ensures a price for the crop, into gambling on the market.

In his letter to grain buyers, Kruse said farmers have become increasingly frustrated at the lack of response by cash grain prices to the higher futures prices offered on the Chicago Board of Trade.

“At a time that the market appears to be rallying to give farmers an opportunity to recoup increased production costs from fuel, fertilizer and other energy related inputs, nearly all of the increase has been negated by a widening of the basis,” he said. “This is very disheartening for farmers, who are understandably asking "why?"

“From a farmer’s standpoint, it appears that grain companies may be taking advantage of their position to gain at the farmer’s expense.”

Kruse said Missouri Farm Bureau has received many phone calls and contacts from its members with concerns about the widening of the cash wheat basis during the month of May. He asked the grain buyers to provide an explanation of the increasing cash basis, particularly during the harvest season.

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