Gold: Surviving in a drought market is possible with planning
By Jennifer M. Latzke
Mark Gold, managing partner of Top Third Ag Marketing, challenges producers to use marketing strategies to weather this drought.
Gold spoke at the 2012 Bayer ProfitMaximizer summit in Wichita, Aug. 1. He said this current drought is as serious as the one the country saw in 1988, and commodity prices are responding.
Gold said drought damage across the Midwest will push the corn crop closer to 10 million bushels rather than the July estimate of 11 million bushels.
"I don't believe the government will tell us how bad the crop is until after the election," Gold said. "They'll grind the numbers lower over time. The fact is we have damage out there." Crop progress reports pegged the nation's corn crop to 48 percent poor to very poor and the soybean crop at 37 percent poor to very poor--very similar to what the country saw in 1988. With still no significant rains on the horizon, that means a huge crop insurance payment this year to farmers, he added.
"I've seen estimates of $10 billion and I think that's a realistic number," Gold said.
For farmers with crop insurance and who will expect claims on their corn or soybeans, Gold advised them to use put options to protect those insurance payments.
"We know what the spring price was on corn and soybeans, we don't know what the fall price in October will be," Gold said. "If between now and October we go back to those spring price levels you'll leave a huge insurance payment on the table.
"I want you to think about a put option as an insurance policy," he continued. "You pay the premium and you hope you don't collect on the put."
Gold gave the example if producers looked at December corn at $8 per bushel and they could buy a December corn put option of $7.50 for 35 cents, the net put in the floor on corn would be $7.15. If at harvest corn falls to $6, $5 or $4 per bushel, the farmer would be protected by that net at $7.15 price level, he explained. If things stay bad and demand stays good, corn rises to $10 per bushel, the farmer will lose the 35 cent premium. But hopefully they would have either the crop to sell at $10 per bushel, or they have an insurance payment above the $7.15.
If you go back to the spring price, however, you lose a huge insurance payment on the table, he said. "If we go back to $5 corn, you protected $8 corn," Gold said. "Put options, like any other insurance policy, you want to lose the premium. You want to see corn go to $8 or $10 this year." It's like a life insurance premium you pay each year--you want to lose the premium and not have to collect on the policy, he said.
We don't want prices to go down, but if the market has a problem and it does go down, you're protected out there, Gold said. The spring average price for corn was set at $5.58 per bushel for revenue insurance, Gold explained, and the price July 31 was at $8.10 per bushel. If corn trades back to that $5.58 spring price level, and a farmer hasn't bought put options to protect his price, he stands to leave $2.52 per bushel on the table. "On a 100,000 bushels, that's $248,000--almost a quarter of a million dollars--if corn goes back to $5.58 between now and October," Gold said. "You can't afford to lose the crop and to lose the insurance payment as well. Please don't get caught up in mentality that this market can't go down."
The No. 1 rule Gold said farmers must follow is to not speculate on the markets. "The odds of someone in the general public beating the pros in Chicago as a speculator are about 7 percent," he said. Speculating is a tough and brutal game and an easy way to lose money fast, he added.
"I don't have a clue if corn will go to $10 or $12 or back to $4," Gold said. " I do know that spending 35 cents to protect the price at these levels is good risk management. We're spending 35 cents to protect at least $3--that's a 7:1 risk-reward ratio. That's a trade you have to make in my opinion."
Wheat prices are the same, and with this drought affecting Iowa, Illinois and Indiana, farmers there are looking to tear up corn acres and plant wheat in the hopes to make money, Gold explained. "If they can get it in in these dry conditions and farmers around the world see the same, we're in for a huge crop in the next nine months," he said. "If that's the case, will we be able to sustain $10 wheat? I know if I can spend 50 cents to buy a put and protect $8 wheat that's a net of $7.50. That's an 8:1 risk to reward ratio. And you're telling me that $7.50 isn't worth protecting because 50 cents is too much?"
Gold also warned farmers against selling their calls to pay for their put options. "I just told you it will cost you $35,000 to $40,000 to protect your risk, and your broker tells you you can sell your call options to pay for your puts and now it's free," Gold said "What's the worst that can happen? You sell an $8.50 call to pay for a $7.50 put and you might have to deliver $8.50 corn?
"That's not the worst that can happen," he said. "If corn goes to $10 per bushel your first problem is the margin call. Then if it goes to $11 per bushel you have another $100,000 check to write on those 100,000 bushels." By this time, your bank won't lend you more money to meet those margin calls, so you lift the hedge which turns you into a speculator and is not likely to succeed, he added.
"Margin calls put emotions into this game," Gold said. "If you are going to be a successful marketer, you have to take emotions out of game. If start putting marginable trades and prices go higher the emotions will kill you in a drought. We don't know how high these prices will go."
Likewise, farmers should not assume that these drought market prices won't go back down, Gold said.
"Let me tell you folks, these prices can and potentially will go back down," Gold said. "Every time we've had a bull market caused by drought, prices go under the cost of production within 18 months. Every one." It's the response of farmers around the world planting more corn at these higher levels and the demand for corn at those higher levels going down.
"These markets are really here to force out inefficient producers," he said. Efficient producers, though, protect their risks, Gold emphasized.
Jennifer M. Latzke can be reached at 620-227-1807 or firstname.lastname@example.org.