The record-large 13.925 billion bushel corn crop harvested last fall helped restore profitability and optimism in the cattle feeding sector. From the pre-harvest high of $5.175/bu, March 2014 corn futures dropped $1.095/bu to $4.08/bu on January 10, 2014. Not only did that result in feeder cattle prices getting bid up to record high levels, but cattle feeding margins also moved back into the black in the first quarter of 2014 after nearly three years of deep losses. The drop in corn prices also served as another catalyst to increase the size of the beef cow herd. In many respects, that drop in corn prices in the fourth quarter of 2013 renewed cattle feeders’ hope of positive feeding margins for the year to come. Contrary to those hopes of cattle feeders and many grain market analysts’ expectations, the corn market has staged a fairly impressive rally since bottoming on January 10. In fact, March 2014 corn futures have risen about $0.80/bu since then.
A number of factors have contributed to this somewhat unexpected corn price increase. The situation in Ukraine created uncertainty about grain exports from the Black Sea region, causing world buyers to look to the United States to fill orders. The rally in the soybean market, caused by strong exports, also buoyed the corn market. Good ethanol processing margins and increasing livestock numbers provided additional domestic demand support. Now, as focus begins to shift to the 2014 corn crop, drought conditions are expanding in the western Corn Belt, and much of the country remains colder than normal, which might delay corn planting. Further, corn growers indicated that they intend to reduce corn planted acreage by almost 4% from last year, according to USDA’s Prospective Plantings report. If realized, that would put 2014 planted acreage at 91.691 million acres – the smallest corn acreage since 2010.
These bullish factors have driven corn prices higher at a time when many cattle feeders and other corn buyers didn’t have procurement hedges in place. Now, after an $0.80/bu rally, an appropriate question to consider is whether some type of hedge or risk management strategy should be used to protect against further corn price increases. While the bullish factors above are valid in that they raise expectations for higher prices, it is also important to consider the bearish argument. March 1, 2014 corn stocks totaled 7.01 billion bushels according to USDA. That’s 30% higher than a year ago, indicating that there are substantially more available supplies this spring. However, the majority of the increase in corn stocks is being held by growers in on-farm storage (up 45%). Commercially stored corn stocks are only 15% higher than a year ago. On the new crop side, it is still quite possible to have a very large (maybe record) number of bushels produced despite the decline in planted acres in 2014. While production risks abound and will be much of the trade’s focus in the upcoming months, at this point there is little to suggest that a national trendline yield of around 165 bushels per acre isn’t still possible. Assuming such a yield and typical acreage abandonment, a 13.9 billion bushel crop could still be harvested this year, which is near 2013 production.
Perhaps the important message for corn buyers that has emerged in the last couple of months is that more “ifs” are present than previously expected. As we near planting season, the possibility of early planting appears to be decreasing, and the once-confident forecasts for a trendline yield this year are being shaken by expanding drought. While the upside of the corn market will be limited by ample old-crop stocks and likely large new-crop production, the need to manage the risk associated with higher corn prices is increasing. While locking in the next two to three months of corn feed needs with cash forward contracts is a reasonable strategy, buyers do not need to be in a hurry to lock in flat prices at this point. Because so much corn is being held in farm storage, there is a lot of corn that needs to be sold and shipped yet as farmers clean out storage in preparation for the 2014 crop. As that cash movement occurs, basis is likely to weaken considerably. Therefore, a futures or options strategy that protects against higher price levels while leaving the long hedger open to the weaker basis may be preferable. And, in contrast to recent years, physical procurement of corn in the next few months shouldn’t be much of a concern. Unless the possibility of significant damage being done to new-crop corn production becomes reality this summer, corn prices could ultimately decrease by mid-summer following additional strength early in the growing season. Should that occur, a maximum price strategy using call options would provide the protection against higher prices and the flexibility to realize lower prices.
While only a couple weeks remain for May options, at-the-money call options near $5.00/bu can be purchased for a few cents. Looking to the June and July corn call options, premiums for at-the-money coverage could cost up to $0.25/bu. Long corn hedgers could move to out-of-the-money strike prices to make the premium more affordable or simultaneously sell an out-of-they-money put option to create both a maximum and minimum purchase price, thereby creating a fence-type window of protection. Whether or not an individual cattle feeder needs corn price protection depends upon their feeding budgets, physical supply of corn, and other factors. But, it does appear that in the next couple of months, the corn market will be more risky that it was this last winter.