BASICS GRAIN trying to secure limited supplies . Basis levels in all locations were much higher reflecting the shortage of corn on the farm and limited availability elsewhere . The basis got stronger .
The opposite is true in a surplus year . Excess supply and limited storage space put downward pressure on cash prices as buyers have plenty of grain from which to choose . This results in a lower than normal relationship between cash prices and futures prices . The basis is weaker .
It is normal in commodity markets to see prices listed on the futures exchange that are higher than the current or spot price . Typically , the farther out you go in the current marketing year , the higher the listed price . That is called a forward curve . When the forward curve slopes upwards , the market is said to be in contango : it is cheaper to buy the commodity today than it is at some future date using a futures contract . That is the normal price condition given the cost of storage . That does not suggest that the cash price is going to go up over the next several months . All that means is that those higher prices are what the price would be today if you wanted to enter a contract for future delivery .
The futures price compares my costs if I bought corn today and held it for two months ( spot price plus storage ) or buy it based on a futures contract for delivery in two months . If my storage costs are 5 cents per bushel per month , my cost of corn today for use two months from now equals the sum of the spot price plus 10 cents . It makes sense that the futures price for a contract that expires in two months would trade at a premium to the spot price or nearby contract of about that same price difference .
As we move through time and roll from one contract month to the next — and if there is no change to the underlying supply and demand conditions — futures prices will tend to decline and converge downward to the spot price . The basis relative to the nearby contract may change at rollover to account for the implied cost of storage that is different for the nearby contract that is expiring to a new nearby contract that is still several months from expiration .
Take for example an elevator that offers a cash price of 368 in late February — the March corn futures contract is trading at 365 and the basis is + 10 cents . In early March , the elevator rolls to use the May contract as the reference contract to set the cash price since the March will soon expire . May is trading at 373 . If the underlying supply and conditions that determine the spot or cash price are unchanged , the cash price is still 368 and the basis is + 2 cents .
The basis went from + 10 one day to + 2 the next because the reference futures price changed . With the market in contango , the May is trading at a premium to expiring March because it is still two months from expiration and reflects a major portion of the cost to store corn for that long . The change in the basis reflects that relationship . If , as we move through time , supply and demand conditions remain the same , we would expect the nearby futures contract , the May in this case , to decline and the basis to strengthen until the end of April when the elevator rolls from the May to the July contract . The process then repeats .
While we usually focus on quotes from the commodity exchanges in our discussions of price , it is important to not equate the futures price to cash price expectations . Futures prices must be adjusted by the basis in your area to determine the expected cash price . The basis will reflect not only normal handling and transportation costs , but supply and demand conditions as well . It is important to track your basis and know its trends in order to make the most informed marketing decisions .
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