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 Newcomers to agriculture
may hear older farmers talking about basis. They might hear that
when basis is negative and the cash is lower than the futures, then
the local market has enough of given crop. Too much supply in the
market, and the basis falls. Should the market have less supply, the
basis can be positive with the cash over the futures.
So why is that important?
Contemporary cash prices have an effect on future prices. When the
basis across the country is rising, futures prices may rally. Being
aware of the basis can give traders insight into the local grain
markets.
According to Alan Kuis of Prairie Farmer, “basis is the difference
between the cash price paid for your grain and the nearby Chicago
Board of Trade futures price.” Basis is sometimes referred to as
"the voice of the market.” This title comes from an indication on
whether or not the market “wants” your grain.
Iowa State University Extension grain marketing economist Chad Hart
adds, “Basis can be a great signal to help farmers figure out where
to sell their crops and improve profitability… Basis can also help
provide a signal as to who their customers are and if demand is
growing or shrinking.”
When the cash basis is narrow or shrinking, the market “wants” your
grain. Such a change often happens “right after the crop has been
put away, or in spring when everyone is busy in the field and no one
is making cash grain sales,” writes Kuis.
A broadening cash basis means holding on to grain a little longer.
Kuis adds that “if you're a farmer who understands merchandising,
you make two decisions when you price your grain. One is choosing
the futures price that you are satisfied with and the other is
locking in the basis level.”
Basis contracts are different from price-later contracts. The
difference comes from when the basis is established; either when the
contract is signed up front, versus when the grain is delivered to
the buyer.
Three factors make up basis for grain. The first is the cost of
transportation. Barge and rail rates change all the time, which
affects the basis. Costs of transportation will change depending on
things like time of year and overall climate.
The second factor is the cost and availability of necessary storage.
If elevators run out of storage space, they may have to increase
their basis to avoid storing more grain in piles outside. If a large
crop results in less available space, the basis will also widen.
The third factor is the relative price level of grain at a given
time. If grain futures rally, it becomes harder for basis levels to
improve. When a crop is larger and futures are low, basis levels are
less likely to stay wide for very long.
The question becomes; how can you use basis when making financial
decisions?
First, be aware of what the basis is in the local area. Talk to
people like elevator managers and grain brokers, who can help you
understand the area better in economic terms.
Second, learn when basis levels are likely to be lousy, and when
they're likely to be good.
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 Third, avoid harvest sales
whenever possible. Sales made right out of the field are usually
made at the worst basis, and you probably won’t be able to make it
back in the futures or options markets.
Finally, watch the futures market and any higher bids for future
delivery in the market. By evaluating the futures market and your
own basis bids, you can often find the best time to enter the
market.
Remember, though, that there is still a risk to be had. Hart warns
that “the risk by using a basis contract is that I’ve locked in one
piece of the price, but the other part could still decline… once
committed to that buyer, if a better price comes along later on, I
can’t move those same bushels to a different buyer for a better
price.”
To summarize, then, the futures market reflects forward pricing and
hedging opportunities for producers and buyers. Cash prices reflect
the futures price, less or plus the basis. Basis is then adjusted to
either encourage or discourage delivery of product.
Basis is a signal of market forces at work and will change over
time, as it reflects both the cost of marketing grain and the
competition between buyers. Farmers should carefully observe basis,
cash, and futures market prices to select the perfect time to price
their grain. Refusing to sell grain just because the basis is too
weak could be worth the risk later, or it could mean a lower cash
price at a later date when time is running short.
By studying basis patterns and using those patterns, your hard work
can pay off big in greater dividends. The futures market is often
very volatile and difficult to estimate, but careful attention can
get you through ever-changing economic times.
[Derek Hurley]
Sources
Alberta Agriculture and Forestry, et al. “Basis-
How Cash Grain Prices Are Established.” Alberta Agriculture and
Forestry, 23 Oct. 2017
Kluis, Alan. “Understanding
Basis Signals In The Grain Markets.” Farm Progress, Prairie
Farmer, 31 Mar. 2000
Swoboda, Rod. “Understand
Basis Contracts for Grain Marketing.” Farm Progress, Prairie
Farmer, 11 Dec. 2017
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