Marketing: Unimaginable? Protect against climbing corn prices, and keep your options open if they fall

By Matt Mattke

Put yourself in position to benefit, no matter which direction the market moves.

The overwhelming herd mentality towards grains prices is bullish and, in some cases, euphorically bullish. The consensus is grain prices are going to continue moving higher. Many market analysts/traders have taken their prognostications one step further, saying grain prices are going to stay high for the next couple years, with supply unable to keep up with demand.

There are definitely many good reasons to be bullish: The trend is still up on the charts; inventories remain tight; ethanol demand is high and seems unaffected by higher corn prices; energy prices have been making new highs; and weather issues are emerging for Argentina’s corn crop. These factors, and others, suggest a very real risk of corn prices continuing to move higher.

The questions many dairy producers are  asking in response are:

• How high can the price of corn go?

• How long can these high prices last?

Both questions are difficult to answer, because emotions and irrational exuberance can take prices to levels well beyond what one would think the fundamentals justify. The old adage, “expect the unexpected,” is especially true with the current commodities markets.

Cotton futures prices in 2010 are a reminder anything is possible. In January 2010, cotton futures prices were at $69/100 lbs.; by December 2010, they hit an all-time high of almost $160/100 lbs. Nobody expected or imagined cotton prices that high.

The point is, dairy producers must prepare and protect themselves – both on the feed side as well as on the milk side – from those unexpected/unimaginable types of market scenarios. Those unimaginable market scenarios apply to both UP markets and DOWN markets. Going forward, you must be open to the possibilities of either $10.00/bushel corn or $2.00/bushel corn; be protected against the first scenario, but able to participate in the second scenario.

This does not require psychic powers or the ability to predict the future. It requires strategies that accommodate many market scenarios.

For example, right now the trend – and risk – is still for higher corn prices. On the other side of the coin, $5.00/bushel and higher corn prices have not lasted long in the past. There is the other old adage, “high prices cure high prices,” and $5.00 and higher corn prices have done a good job of fixing supply/demand imbalances in the past. Every rally over $5.00 has eventually been followed by a sell-off down to $3.00.

Buy corn, put options

Thus, there are dollars per bushel of risk and opportunity in both directions from the current market price of about $6.00. For a producer who still must buy corn for 2011, a strategy should be implemented that protects against the unimaginable upside risk, while still providing participation in the unimaginable downside opportunity. A strategy accommodating both is buying the physical corn and protecting the purchase with put options.

Buying the physical corn protects against higher prices. If a dairy producer has $6.00/bushel corn bought, and corn goes to $8.00/bushel, they are locked in at $6.00/bushel.

However, if corn goes to $2.00/bushel, they’re still locked in at $6.00/bushel. The latter scenario is where the put option coverage comes into play. If $5.50 put options are purchased at 30¢/bushel, and corn drops to $2.00/bushel, put options would provide $3.20/bushel of downside price protection. That would effectively reduce the purchase price on the physical corn from $6.00/bushel to $2.80/bushel.

Bottom line, complementing cash market purchases of corn feed or protein feed with put option protection can give a dairy producer a feed hedge position that protects them, no matter what unimaginable price development comes in 2011. If the corn price drops to $2.00/bushel, the producer is covered; if the price rallies to $10.00/bushel, the producer is covered. That is a more attractive position to be in.

FYI

Matt Mattke, Market360® dairy advisor at Stewart-Peterson, can be reached via e-mail: mmattke@stewart-peterson.com, phone: 800-334-9779 or visit www.stewart-peterson.com.

Get Started Marketing Well e-book available for dairy producers

Stewart-Peterson has released Get Started Marketing Well, a book for dairy producers available in electronic (e-book) form. The book walks producers through the process of positioning a dairy business for marketing success, describing key principles  and common pitfalls.

Visitors to www.stewart-peterson.com can read the complete table of contents and an excerpt from the book. Producers can request a free copy of the complete book at the firm’s website or by calling 800-334-9779.

For those who prefer a more interactive learning experience, Get Started Marketing Well webinars are also available at the firm’s website.

background_banner