Profitability of crops

SEASONAL TRENDS 

As the production season progresses, the market responds to current fundamental factors. Should a dry period be predicted during a critical time of the production season, the market should respond by an increase in prices. 

Patterns form over years which clearly indicate periods during which hedging can be done at better levels than other times. The challenge is that fundamental problems such as drought, usually drive the market, which makes hedging decisions very difficult. See the July white maize seasonal trend below. 

It is evident from the graph above that the first seasonal opportunity traditionally arises during November (planting time). During the period, when production certainty is low, it would be sensible to approach hedging by means of minimum prices (put options). Producers are inclined to hedge one third of expected production during this time, while some hedge enough to pay for input costs.

 

The next opportunity arises during February-March (pollination time), which is mostly at the same time as the traditional midsummer drought. Producers who have more production certainty at this stage, may consider buying back the minimum prices bought during planting time and taking fixed prices instead. This consideration will, however, depend on the difference between the premium paid and the premium which can be recouped with the resale. Alternatively, the next third of production can be hedged by means of fixed prices.

The last third is left until approximately May (harvest time), but producers are also inclined to make sure of the final tonnages harvested before the last production portion is marketed. The traditional price increase from July to December is, however, utilised by producers to a large extent in the form of deferred pricing or derivative instruments, by means of which the upward potential can be utilised.

The above strategy offers the opportunity to utilise various opportunities in the market. A conservative approach ensures that adjustments can be made continuously to the tonnages being hedged and that more tons than realistically expected, are not hedged. 

Graph 1: The long-term July contract white maize price and 2019 price movement on Safex.

The factors which will probably play a significant role in domestic prices, are discussed below.

The domestic market is sensitive for movement in the rand/dollar exchange rate. This rate has a huge impact on imports and exports, which determine the bands within which the local market should theoretically trade. 

The rand is currently in a downward phase, mainly due to poor economic prospects on the local front and a strong American dollar. The weaker currency results in local commodities being more competitive internationally and it stimulates exports.

Any extraordinary movements (as seen recently, up to R1,30/dollar in one day) can be used, should a hedging decision be made at that stage.

The El Niño effect has a huge impact on rainfall, particularly during the critical time around December - February. 

An El Niňo effect impacts particularly the westernproduction area. Although the time of rainfall is more important than the quantity of rain, concern about a possible drought could be made worse by the presence of an El Niño event. The expectations in respect of an El Niño event for the summer season, are indicated below:

Graph 2: El Niño probability.

It is evident that the probability of an El Niňo for the coming season is very strong. The effect of an El Niňo for this season is not expected to be very severe, but the presence thereof could result in an overreaction in the market as a result of predicted dry conditions.

Uncertainty about planting levels could drive prices in the coming season. The function of the market is to incentivise producers to plant, despite the risk of, for instance, drought. However, certain additional factors may result in more uncertainty during the coming season. These factors include the relatively better profitability of sunflower, uncertainty regarding the land issue, concern about a possible El Niňo, producer cash flow being under pressure, etcetera. It must be borne in mind that the market is driven by uncertainty and that one has to look past all these uncertainties, to profitability, in order to determine when hedging should be done.

Although significant closing stock levels in respect of maize are still expected, the impact of exports and increased consumption levels cannot be ignored. Consumption and exports are currently at high levels. Should these levels remain higher than expected, prices may move away from export parity levels, which will ensure more certainty about domestic stock levels.

In respect of oilseeds, an excess of soybeans is still expected. Domestic press capacity is not sufficient to process total production levels. The sunflower situation is, however, totally different. The sunflower consumption rate is very high and there is a possibility of stock levels being very low towards the end of the season.

The domestic market will probably be driven by uncertainty during planting time (and even later). One should look past these uncertainties when deciding about hedging. The hedging strategy should be planned in advance and can be adjusted dynamically according to new market information. Please phone you grain marketing consultant or Safex broker for assistance in this regard.