Agricultural Marketing

1. Agricultural Marketing Frayne Olson North Dakota State University Frayne.Olson@ndsu.edu Chad Hart Iowa State University chart@iastate.edu

2. Marketing A series of events and services to create, modify, and transport a product from initial creation to consumption Possible steps: • Planning • Production • Inspection • Transport • Storage • Processing • Sale Market players: • Producers • Elevators • Processors • Transport companies • Banks/Insurance companies • Traders • Feeders

3. Market Functions Where do you want it? • Location • Time • Form • Price discovery When do you want it? How do you want it? What will you pay for it?

4. Cash Markets A market where physical commodities are traded • Local elevators • Ethanol plants & soybean crushers • River terminals • Feeders/feed mills

5. Futures Markets A market where contracts for physical commodities are traded, the contracts set the terms of quantity, quality, and delivery • Chicago: Corn, soybeans, cattle, hogs • Along with wheat (soft red), oats, rice • Kansas City: Wheat (hard red winter) • Minneapolis: Wheat (hard red spring) • Tokyo: Corn, soybeans, coffee, sugar • Has a market for Non-GMO soybeans • Other markets in Argentina, Brazil, China, and Europe

6. The Cash and Futures Markets Are Related Basis = Cash price – Futures price Rearranging terms: Cash price = Futures price + Basis So national (and international) events can affect local prices

7. Market Activities • Pricing the commodity • Establishing contracts • Merchandising the commodity among uses • Transporting the products • Storing the products • Managing and controlling the products • Managing production and price risks

8. Price Determination and Discovery Price Determination • is the broad forces of supply and demand establishing a market clearing price for a commodity. Price Discovery • is the process by which buyers and sellers arrive at a specific price for a given lotof produce at a given locationfor a specifictimeperiod.

9. Price Determination and Price Discovery S P Pe D Q Qe

10. Futures Markets • Organized and centralized market • Today’s price for products to be delivered in the future • A mechanism of trading promises of future commodity deliveries among traders

11. Futures and Options • Market tools to help manage (share) price risks • Mechanisms to establish commodity trades among participants at a future time • Available from commodity exchanges / futures markets

12. Agricultural Futures Markets • Has some unique features due to the nature of agricultural businesses • Supply comes online a few times during the year • So at harvest, supply spikes, then diminishes until the next harvest • Production decisions are based price forecasts • Planting decisions can be made a full year (or more) before the crop price is realized • Users provide year-round demand • Livestock feeding, biofuel production, food demand

13. Futures Market Exchanges • Competitive markets • Open out-cry and electronic trading • Centralized pricing • Buyers and sellers are both in the market • Relevant information is conveyed through the bids and offers for the trades • Bid = the price at which a trader would buy the commodity • Offer = the price at which a trader would sell the commodity

14. Futures Market Exchanges • Modern futures market began long ago • 1848 -- Chicago Board of Trade • 1898 -- Chicago Mercantile Exchange • 2007 -- CME Group merged CBOT and CME • Highly regulated markets • Commodity Futures Trading Commission (CFTC)

15. The View from the Corn Pit Source: M. Spencer Green, AP Photo

16. Futures Markets • Organized and centralized market • Today’s price for products to be delivered in the future • A mechanism of trading promises of future commodity deliveries among traders

17. Futures and Options • Market tools to help manage (share) price risks • Mechanisms to establish commodity trades among participants at a future time • Available from commodity exchanges / futures markets

18. Agricultural Futures Markets • Has some unique features due to the nature of agricultural businesses • Supply comes online a few times during the year • So at harvest, supply spikes, then diminishes until the next harvest • Production decisions are based price forecasts • Planting decisions can be made a full year (or more) before the crop price is realized • Users provide year-round demand • Livestock feeding, biofuel production, food demand

19. Futures Market Exchanges • Competitive markets • Open out-cry and electronic trading • Centralized pricing • Buyers and sellers are both in the market • Relevant information is conveyed through the bids and offers for the trades • Bid = the price at which a trader would buy the commodity • Offer = the price at which a trader would sell the commodity

20. CME Group • http://www.cmegroup.com/ • Products • Agricultural commodities • Corn, soy, cattle, hogs, etc. • Energy • Currency • Metals • Weather • Others

21. Futures Contracts • A legally binding contract to make or take delivery of the commodity • Trading the promise to do something in the future • You can “offset” your promise • Standardized contract • Form (weight, grade, specifications) • Time (delivery date) • Place (delivery location)

22. Soybean Futures • Form • 5,000 bushels • No. 2 Yellow Soybeans (at price), No. 1 Yellow soybeans (at 6 cents over price), and No. 3 Yellow Soybeans (at 6 cents under price) • Time • Contract months: Sept, Nov, Jan, Mar, May, July, and August Source: CME Group

23. Soybean Futures Partial listing of delivery points Source: CME Group Rulebook

24. Delivery Points Corn Soybeans Wheat Source: Irwin, Garcia, Good, and Kunda, 2009 Marketing and Outlook Research Report 2009-02

25. Futures Contracts • No physical exchange takes place when the contract is traded (no actual commodity moves) • Payment is based on the price established when the contract was initially traded (prices can and will change before delivery is taken) • Deliveries can be made when the contract expires or the offsetting futures position must be taken to settle up • Deliveries occur on less than 5 percent of the traded contracts

26. Market Positions • You can either buy or sellinitially to open a position in the futures market • “Make” a promise to make or take delivery • Do the opposite to close the position at a later date • “Offset” the promise (and no commodity changes hands) • Trader may also hold the position until expiration and make or take physical delivery of the commodity

27. Trading Futures Contracts • All trades through a licensed broker • Brokerage house has a “seat” at the exchange and is allowed to trade • Represented “on the floor” to exercise trade • Local broker to initiate transaction and manage account with client • Full service and discount brokers

28. CME Group • http://www.cmegroup.com/ • Open, High, Low, Last Price • Settlement Price • Volume • Open Interest • Daily Limits

29. Terms and Definitions • Basis • The difference between the spot or cash price and the futures price of the same or a related commodity. • Bear • Someone that thinks the price will decline • Bull • Someone that thinks the price will increase

30. Cash vs. Futures Prices Iowa Corn in 2015 The gap between the lines is the basis.

31. 2015 Basis for Iowa Corn

32. Terms and Definitions • Clearing House • The division of the futures exchange through which all trades made must be confirmed, matched and settled each day until offset or delivered. • Commission • For futures contracts, the one-time fee charged by a broker to cover the trades you make to open and close each position.

33. Terms and Definitions • Long position • A position in which the trader has bought a futures contract that does not offset a previously established short position. • Short position • A position in which the trader has sold a futures contract that does not offset a previously established long position.

34. Going Short Sold Dec. 2016 Live Cattle @ $124 What type of trader (bull or bear) would go short? What events would send prices in a favorable direction?

35. Going Long What type of trader (bull or bear) would go long? Bought Dec. 2016 Lean Hogs @ $62 What events would send prices in a favorable direction?

36. Margin Accounts A margin account is an account that traders maintain in the market to ensure contract performance. There are minimum limits on the size of the account. Crop Trader Type Initial Maintenance Corn Hedger/Speculator $1,100 $1,000 Soybeans Hedger/Speculator $2,310 $2,100 Lean Hogs Hedger/Speculator $1,320 $1,200 Live Cattle Hedger/Speculator $1,980 $1,800 To trade, you must create a margin account with at least the “Initial” amount and maintain at least the “Maintenance” amount in the account at the end of each trading day.

37. Margin Calls • Margin accounts are rebalanced each day • Depending on the value of futures • Settlement price • If your futures are losing value, money is taken out of the margin account to cover the loss • If the account value falls below the “Maintenance” level, you receive a margin call (a call to put additional money in your margin account) and the balance is brought back up to the Initial amount

38. Margin Example • Let’s say I went short on Mar. 2016 corn • $3.5175/bushel on Jan. 11 • Along with selling a corn futures contract, I have to establish a margin account and deposit $1,100 in it • On Jan. 15, the Mar. 2015 corn futures price moved to $3.6325/bushel • Since I’ll be buying the futures contract later, this price move is not in my favor

39. Margin Example • I lost 11.5 cents per bushel and since the contract is for 5,000 bushels, that’s a loss of $575 • At the end of the day (Jan. 15), my margin account will be tapped for $575, lowering the account balance to $625 • Since $625 is less than the “Maintenance” level ($1,000), I will receive a margin call and be asked to deposit $575 more into the account or to close out the futures position • The $575 brings the account balance back up to the initial requirement

40. Margin Example #2 • Let’s say, instead of going short, I went long on May 2016 corn • $3.575/bushel on Jan. 11 • Along with buying a corn futures contract, I have to establish a margin account and deposit $1,100 in it • On Jan. 15, the May 2015 corn futures price moved to $3.675/bushel • Since I’ll be selling back the futures contract later, this price move is in my favor

41. Margin Example #2 • I gained 10 cents per bushel and since the contract is for 5,000 bushels, that’s a gain of $500 • At the end of the day (Jan. 15), $500 will be added to my margin account, raising the account balance to $1,600 • Since $1,600 is greater than the “Maintenance” level, I will not receive a margin call

42. Margin Example – Going Short

43. Margin Example – Going Long

44. Market Participants • Hedgers are willing to make or take physical delivery because they are producers or users of the commodity • Use futures to protect against a price movement • Cash and futures prices are highly correlated • Hold counterbalancing positions in the two markets to manage the risk of price movement

45. Hedgers • Farmers, livestock producers • Merchandisers, elevators • Food processors, feed manufacturers • Exporters • Importers What happens if the futures market is restricted to only hedgers?

46. Market Participants • Speculators have no use for the physical commodity • They buy or sell in an attempt to profit from price movements • Add liquidity to the market • May be part of the general public, professional traders or investment managers • Short-term – “day traders” • Long-term – buy or sell and hold

47. Market Participants • Brokers exercise trade for traders and are paid a flat fee called a commission • Futures are a “zero sum game” • Losers pay winners • Brokers always get paid commission

48. Hedging • Holding equal and opposite positions in the cash and futures markets • The substitution of a futures contract for a later cash-market transaction • Who can hedge? • Farmers, merchandisers, elevators, processors, exporter/importers

49. Cash vs. Futures Prices Iowa Corn in 2015

50. Short Hedgers • Producers with a commodity to sell at some point in the future • Are hurt by a price decline • Sell the futures contract initially • Buy the futures contract (offset) when they sell the physical commodity