Welcome to Part 2 of ARM’s special 2-part series on grain marketing in times of commodity price volatility. In this issue, we will explore how to capitalize on market opportunities as they arise, particularly during price rallies. The commodity markets have experienced significant volatility in recent months, leaving many feeling uncertain. Opportunities can emerge both when we anticipate them and when we least expect it.
Having a strategic marketing plan in place for 2025 will enable you to act swiftly and seize these rallies as the occur. Scale selling into rallies, also known as the “inverted pyramid method,” is a proven strategy to decrease price risk.
The inverted pyramid focuses on scaling your sales during market rallies. Secure profits during a rally by selling a small portion of your anticipated production at the beginning of the rally. As prices rise, gradually increase the volume of your sales at higher price points, which allows you to capitalize on progressively larger profits throughout the rally, while still leaving room for potential gains at the peak. This strategy mitigates risk by locking in profits throughout the series of sales.
For example, consider selling**:
-5% of your production at $4.60/bu on day 5
-10% at $4.75/bu on day 10
-15% at $4.90/bu on day 30
**Percentages are for demonstration purposes only
How is this approach beneficial? Let’s delve into the concept of a weighted average, which calculates the average price based on the volume of sales at various price points. In the scenario mentioned, if you lock in sales at three different levels – 5% of 5,000 bushels, 10% of 10,000 bushels, and 15% of 15,000 bushels – the weighted average price for these sales would be $4.80, just a dime shy of the peak.
However, consider the possibility that the expected third level of $4.90 never occurs. If the market begins to decline after hitting $4.75, you might find yourself in a rush to sell before prices fall further. If you end up selling everything at $4.55, you’ve missed out the opportunity to capitalize on higher prices. Conversely, had you implemented scale selling and sold at $4.60 and $4.75, your weighted average would have been $4.70, resulting in a loss of $0.15 by waiting.
This method is beneficial not only for new crops but also for old crops. Incremental sales during a price rally can yield better returns than attempting to sell everything at a peak price. How is this achievable? Recall the discussion in Part 1 of this newsletter about carrying costs. By reducing your debt tied to the crop with each incremental sale, you effectively lower your carrying costs. For example, if your carrying cost is $0.10 per bushel per month and you manage to halve your associated debts during the month, your carrying cost could decrease to $0.06 per bushel. As we know, net income consists of revenue minus expenses. Even if your revenue increases, your net income will not rise if your expenses also continue to climb.
The takeaway here is that risk is inherent in this business, but the way you manage that risk significantly impacts your overall success. Instead of holding out for a single major opportunity to sell all at once, consider each phase of a market rally as a chance to secure profits. By taking advantage of these incremental opportunities, you can effectively manage your returns and reduce the risks associated with market volatility.
For a visual example, see exhibit A below:
Let’s explore this concept further with an example, utilizing some of the insights from above along with the accompanying table below. This table illustrates three incremental sales of a total of 70,000 bushels of corn, made over a span of 30 days. For this scenario, we assume that the funds from each sale are applied to existing debt. This approach is contrasted with holding onto all crops for 30 days and selling them at the highest price point ($4.85). At first glance, it appears holding out would be most lucrative ($335k vs $339.5k), but what about the cost to carry? The cost associated with holding the crop for a full 30 days at $0.10/bushel would equate to $7,000 whereas the cost to carry when reducing debt across the first 2 sales would bring the cost down to $0.06 or $4,200. When considering this information, waiting a full 30 days to sell “at the top” only yields an additional $0.02 per bushel or $1,700. Is $0.02 per bushel worth the risk in the event the market does not continue upwards?
Now, let’s examine another scenario: Picture the market not reaching $4.85. Instead, it peaks at $4.75 and then steadily drops to $4.65 while you maintain your position. In this scenario, delaying your sale could result in a loss of $0.04 per bushel. By employing the scale selling strategy, you could achieve a weighted average price that is $0.02 higher than the $4.65 at which the held grain ultimately sells. Furthermore, utilizing scale selling would also reduce your carrying costs by $2,800. By strategically managing your risk in this situation, you can enhance your overall profit.
