There are two very distinct sides to a commodity market; the cash side and the futures side. Although both of these can be influenced by the same factors, they are in fact very different. One of the greatest confusions in the market is trying to determine what impacts futures and what impacts cash values for a commodity.
The cash side of a market tends to be more influenced by simple supply and demand. If there is an abundance of a commodity, buyers tend to pay less for needs. A perfect example of this is the current soybean supply in the United States. Soybean crushers know we have an adequate supply of whole soybeans compared to a year ago and are less willing to extend bids. This is generally reflected with a buyer posting a weaker, or wider basis value. This type of a market is commonly termed a “buyer’s” market.
At the same time, a buyer can be forced to push for needs with a better basis. This tends to come in years where production of a commodity is cut short and raw stocks are harder to source. The most recent time this happened in the United States on a wide scale was in 2012. In such years it is not unusual to see a buyer pay a positive basis. This is referred to as a “seller’s” market, as buyers tend to fight over available inventory, and sellers can usually demand higher values.
There are several other factors than can impact a cash side of the market, including cost of transportation and how wide-spread of an area a shortage or abundance of a commodity covers. Buyers in today’s market, especially in crushing and ethanol, have also started to show a willingness to slow or halt manufacturing if raw stocks become too high in value.
The futures side of a commodity tends to be based on more of a wide-scaled picture. Many times commodity futures are set by what is taking place in the world market. Last year was a prime example of this, as even though soybean reserves dipped to an all-time low level in the United States, the global market had more than enough soybeans to satisfy demand. This simple dislocation in inventory caused world soybean values to remain depressed while buyers in the domestic market were forced to push for needs.
Another difference between the cash and futures side of a commodity is how movement is encouraged or discouraged at times. In the cash market this is done with basis. The greater a need for a product, the tighter the basis can get. This same scenario takes place in futures with spreads and carry. When a commodity is not needed we tend to see carry added into futures, meaning a holder of the commodity is paid to store it. We can also see an inverse in futures, meaning buyers want the commodity delivered right now.
One difference between basis and carry is that basis can narrow or widen a basically unlimited amount. Futures can inverse an unlimited amount, but we will only see so much carry added to futures or no spot movement will take place at all, as holders of inventory will wait for the better values. In many years analysts use carry and spreads between contract months as an indicator of true supply and demand.
It is not uncommon to see those involved in trade confuse the cash and futures side. The most recent case of this was when the outbreak of Bird Flu started. Many analysts had thought this would cause panic in the futures market and corn futures would drop. In fact, this was more of a localized issue and instead caused a weakening of corn basis in regional cash markets. Even then corn basis has not collapsed as improved margins in ethanol offset the slower demand from feed.
This said, if we continue to see a lack of demand in the internal market we could see futures react, but this may be slow in taking place.
Bottom line is that there are several factors that determine what a farmer is paid for his commodity. Only monitoring one of these can be a costly mistake.
Karl Setzer is a commodity trading advisor/market analyst based in the West Bend office of MaxYield Cooperative. He can be reached at (800) 383-0003.
The opinions and views in this commentary are solely those of Karl Setzer. Data used for this commentary obtained from various sources believed to be accurate. This commentary is intended for informational purposes only and is not intended for developing specific commodity trading strategies. Any and all risk involved with commodity trading should be determined before establishing a futures position.
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