- MARKETING -
What Does ‘Basis’
|By Andrew McKenzie|
EDITOR’S NOTE: Andrew McKenzie, associate professor of Commodity Marketing at the University of Arkansas Division of Agriculture, discussed “basis” (cash price minus futures prices) and what it means to the farmer at the Rice Field Day in Stuttgart on Aug. 12 at the Rice Research and Extension Center. Following is a summary of the remarks McKenzie made during his presentation.
What is the most important marketing signal to understand?
However, the effectiveness of futures markets to provide price discovery and risk management depends on stable and predictable basis. Under normal circumstances, cash and futures prices should be linked by economic fundamentals, and convergence should result in cash and futures prices approaching the same level at delivery locations during the delivery period.
What is the significance of new crop basis under normal market
What does post-harvest basis mean to farmers under normal market
Basis charts used by grain elevators to merchandise grain, may also be used by farmers to predict and benefit from post-harvest basis movements over time. Farmers using short-futures storage hedges will benefit from basis increases. Grain merchandisers refer to this as going long-the-basis.
From a risk-management standpoint, basis translates futures hedge price into a local realized sale price. When storing cash grain against a short futures position, if basis increases by 50 cents/bushel over the hedge period, you get a 50-cents-per-bushel higher price when you close the hedge and sell the grain.
What are some factors that determine basis?
• Storage space (related to the above) and competing commodities: Corn competing in the South with rice and soybeans can mean weaker-than-normal rice and bean basis.
• Grades and handling: If they shrink as percent is applied to basis, a weaker basis can result.
• Freight or transportation costs: The higher and more volatile costs can mean weaker basis.
• Supply of money or financing: Cost of storing increased with higher prices, more working capital is tied up in huge dollar inventory positions and the risk of higher margin calls can mean weaker basis.
• Uncertainty and risk: Lack of confidence in the short term, less demand, buyers want to take a wait-and-see attitude can mean weaker basis.
• Convergence of cash and futures at delivery time.
What is a ‘weak basis’?
How are elevators affected by high and volatile commodity markets?
This increased risk along with higher hedging costs – in the form of margin calls – and has in turn resulted in elevators removing forward contracting opportunities.
Freight cost is up 40 percent for elevators, and the physical cost of storage is up tremendously. The financing cost of buying grain is up 250 to 300 percent, and margin calls are a huge burden on elevators. Many elevators are only offering forward contracts for 60 days ahead.
What can farmers do to market grain in a high and volatile
• Weak basis is considered to be a market signal to store. Store and basis trade (sell futures against long cash inventory at harvest time and wait for basis to strengthen).
The problems involved are basis risk, high margin calls and working capital to finance positions. You’re in the same boat as the elevators.
• Basis contracts – lock basis risk – if they exist. They’re scarcely offered like forward contracts. Hedge in futures and basis contract gives the same price protection as forward contract.
Since your presentation in August, how will recent drops in
commodity prices affect basis?
Although this is obviously not a positive for farmers selling their crops, if we continue to see prices move back to an historically more normal trading range, I would expect basis to narrow (get less negative, whereby cash and futures prices move closer together) in local cash markets, and for basis convergence to improve.
Also, with oil prices falling, farmer input costs should fall over time.
Contact Andrew McKenzie at (479) 575-2544 or email@example.com.
• Arkansas New Crop Basis Charts
• CFTC Agricultural Advisory Committee Meeting Webcast
• CBOT Understanding Basis Handbook
Six Reasons Why Commodity Prices Increased