Paul Kuntz
When commodity prices dip, we tend to want to stop selling grain. The bills do not stop coming though and we always need cash to operate.
I am not a grain market expert. These strategies that I am going to talk about are ways to not sell your grain today in hopes that tomorrow will bring a better price. History has shown us that this does not always happen. But if you are wanting to hold on to your grain, I will go over a few tips.
The first thing I want to discuss is forward selling your grain. For many of you, this is common practice, but for some of you, this is seen as a big risk. There is risk involved in forward selling grain that you have not grown yet, but there is risk in doing nothing as well. Let’s say between loan payments, land rent and harvest expenses you need $500,000 from September 1 to December 1. If it is March 1, you know you have already committed to spending $500,000 six months from now. You have made contracts to spend that money. We never seem to think of that as a risk, but you have made a contract to spend money. You need to offset that contract to spend money with a contract to earn money.
I know there is a risk of crop failure and contract buyout fees, but you need to be realistic. Look at your historical production records. If you lock in 10 bushels/acre of canola, when was the last time (if ever) you grew less than 10 bushels/acre of canola? Yes, there is a risk, but you need to make a calculated risk assessment.
Again, I am not saying that locking in your crop price in spring for a fall delivery is the right thing to do. But historically speaking, this would be the best way to sell crop off the combine and get a good price.
If you are not going to sell but you need cash, we are left with a few other options. The first is a cash advance. Through Agriculture and Agri-Food Canada, we have access to the Advance Payments Program. This program seems to have only two sides: those who love it and those who refuse to use it. I recommend that every producer who has access to it should use it. This program is one of the few ways the government supports us as farmers. This program allows producers to get up to $1,000,000 in an advance against grain. The first $250,000 is interest free. Then, as you sell grain, you repay it. The program is simple to use and you can get cash even before you seed a crop. Many of my clients use this program every year. They take a spring cash advance and then top it up with a stored grain advance once harvest is complete.
Other clients refuse to use the program because when you sell grain, you do not get all the money. I think this is an unreasonable excuse to not use the program. I also feel that we need to show the federal government that we are using this program so they do not take it away. I think government officials use this program as a barometer to measure the financial well-being of our industry. When our lobbyists are in Ottawa asking for more support, the government will look to the cash advance program. If we are not fully utilizing this program, it is easy for them to reply: “It does not appear your industry is using the programs you have; why would you need more support?” Please use this program.
If you have already used the cash advance program (or perhaps you are ineligible), then you need to look toward operating debt to pay the bills. All farms use some operating debt, so this is not new. What we are talking about here is additional operating debt that has a specific term limit like three to six months and it is over and above your line of credit. This can be a great way to generate cash while you wait for markets to rise.
In the past couple of years, interest rates have risen and one area that has been particularly hit is operating debt. We are seeing our agriculture retailers’ in-house credit running at close to 10 per cent. We need to be sure that this exercise is not costing more money than it is worth. If you need $500,000 for six months and the interest rate is going to be eight per cent, you need to be sure that this pays off. The cost of borrowing that money will be $20,000. If you had 37,000 bushels of canola to sell and the price was around $13.50/bushel, you could sell it and get the $500,000 you need. If you borrow the money for six months and you spend $20,000 in interest, that canola will have to sell for $14.05/bushel just to break even.
If you look at wheat, there is more of an upside with this commodity. You would need to sell 77,000 bushels of wheat at $6.50/bushel to get $500,000. If you spent $20,000 in interest, the price of wheat only has to rise to around $6.77/bushel to break even. Neither of these takes into account the risk of storing the grain.
The last strategy is selling the grain but using the futures market to buy it back to participate in future gains. Again, I need to stress I am not a grain market expert and I am not predicting that grain prices will get better. What I am explaining are strategies you can use if you think the market will improve. The first step is to find a commodity broker. You would think that living in a place like Western Canada where we grow billions of bushels of grain, finding a commodity broker would be easy. It is not. There are not a lot of them around. But you need to find one and interview them to make sure you trust them and that they will look out for you.
A lot of these strategies deal with using the options market. This is a less risky way to participate in the futures markets. You do not actually buy any grain; you buy a right to buy it (or sell it). You pay a price for the option up front and that is the limit to your financial exposure. If it turns out you were wrong, then all you have spent is what your option cost you. If you were right, then your options can be sold for a price more than what you paid for. The bad part about options is that you always leave a little money on the table. If you have an option to buy canola for $13.50/bushel and the price of canola is $14/bushel, you do not get $.50/bushel for your option. That is what it is worth, but someone has to bid on it and buy it so they might bid $.40/bushel. You also need a very active market to make options trading possible and some markets are just not that active.
The commodity that I believe is the best to protect with the futures market is HRSW. We sell our wheat in Western Canada off the Minneapolis exchange of spring wheat. If it goes up a penny, our price goes up a penny (actually it goes up more because it trades in USD). It is also a huge active market with many transactions every day. If you truly believe that the price of your wheat will be higher in the next six months, you can sell all of it today, get the cash to pay your bills, and then with the help of your broker, buy all of your wheat back with a futures contract. You can use the brokerage’s money to do most of the buying through what is called a margin account. This is a fancy name for a line of credit. You put up a little bit of money and they put up the rest. The risk in this strategy is that you now own all of that wheat again and if the price goes lower, you will have to pay that difference. If you buy all of your wheat back at $6.50/bushel and eventually you sell it for $6.25/bushel, then you have to pay $.25/bushel. My argument against that risk is that you were willing to take that risk, anyway. If you have the ability to sell wheat today for $6.50/bushel but instead you wait until it is $6.25/bushel, you are no further ahead or behind.
There are other things that could go wrong that your broker will explain, but again I think it is a calculated risk. Every day, millions of bushels of grain are bought and sold on the markets without devastating consequences. Sometimes you win, sometimes you lose, but rarely is there a wreck. No different from our own grain marketing activities.
I also think this is the best way to understand markets. If you buy 20,000 bushels of spring wheat on the Minneapolis exchange, I guarantee you will follow it and learn it. Once you have done it a few times, you will understand the process and see it as less risky.
If you grow oats, barley, peas, lentils, durum, chickpeas, flax, canary seed, mustard … there is no accurate way to buy back your grain. Your broker will show you some markets that you can take a position in that may replicate these commodities, but they will not follow them penny for penny.
As always, I recommend having a plan for money coming in. We are great at planning for money going out. We sign loan agreements with payments over five years; we sign rental agreements on land for five years; we buy fertilizer in July for a crop we are only growing 10 months from now. We need to think about money coming in as well.
