Tag Archives: grain

2015 El Nino and the U.S. Grain Markets

The National Oceanic and Atmospheric Administration (NOAA) has repeatedly stated the growing case for the 2015-2016 El Nino event. While much has been discussed in the headlines, very little of the conversation has focused on the commodity price impact that the most significant El Nino weather pattern since 1997 could have on U.S. crops. This week, we’ll begin our look at how the U.S. grain markets performed during 1997-1998 El Nino and continue this line of thought through the global grain markets next week before finishing this segment with a look at El Nino’s impact on energy prices.

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COT Report Shows Major Selling Ahead of USDA Reports

The grain markets finally got moving this year once the crops got in the ground. Since March, the soybean market has seen four moves of more than 7.5%, all of which were completed in three weeks or less. Soybeans have increased their volatility substantially while remaining range bound between $9.20 and $10.60 per bushel. With both the USDA’s Crop Production and the World Agriculture Supply and Demand report coming out Wednesday at noon, we’ll take a look at who is in control of the soybean futures market and how their actions in the market telegraph their expectations of tomorrow’s crucial reports.

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Corn Rally Stalls on Commercial Selling

The corn futures market has rallied about 15% off of its lows while following its typical seasonal harvest pattern. We had some serious concerns about how oversold this market had become and wondered if it may even breach the $3.00 per bushel level. Obviously, the market hasn’t fallen below $3.00 and the market’s decline was fully supported by long hedgers looking for bargains below $3.60 per bushel. Long hedger support and the oversold nature of the market put us on the buy side for the recent rally which you can see on the chart below. However, as the market has rallied, so to have commercial traders’ expectations changed.

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Commitment of Traders Report to Turn Supportive of Corn Futures

The Commitment of Traders reports showed that commercial corn producers sold more than 350,000 contracts equal to 1,750,000,000 bushels or, about 12% of this year’s crop as estimated by the October 10th USDA WASDE report between February and April. The average price for these forward hedges was around $5.00 per bushel. The summer’s perfect weather has led to record production and this has caused the market to sell off all the way down to $3.20 per bushel. This sell off has brought out the consumption side of the commercial trader equation and our math suggests that they’re just getting warmed up as you can see on the chart below.

Continue reading Commitment of Traders Report to Turn Supportive of Corn Futures

Finding a Bottom in the Corn Market

The 2013 United States’ corn crop started off with predictions of being the largest ever. This was primarily due to the USDA acreage report issued on June 28th that showed 97.4 million acres planted for corn. This was the highest acreage allotted to corn since 1936 and also marked the fifth consecutive year of acreage gains for corn. This caused December corn futures (this year’s crop) to fall 9% in the next few trading sessions. Even though the market is now trading even lower than it was then, I think there are signs pointing to a bottom in this market. End line users should take advantage of the lowest prices we’ve seen in over a year.

Record planted acreage along with trend line yields would produce the largest corn crop in history. However, the University of Illinois pointed out as recently as last week that the USDA’s planting intentions report of June 28th won’t materialize the way the market initially reacted. The Fighting Illini pointed towards the prevented plantings number to support their argument that corn acreage may be more than 8 million acres less than originally forecasted. This is primarily due to the lateness of this year’s plantings. Furthermore, they comment on the currently declining characteristics of the corn crop condition, which may impact yields if pollination doesn’t get the weather it needs.

We often talk about a market’s, “fear premium.” Fear premium is the market participants’ disproportional concern of the market moving one direction instead of the other. Fear premium in the grain markets is always on the high side. Call options, which make money when the market goes up are always more expensive than put options in the grain markets. The difference between the current market price and the price of a put and a call option equally distant from the current price is 0 in an unbiased market. However, call options currently have a built in fear premium of approximately 30%. Therefore, the markets’ participants are 30% more concerned about prices moving higher by $.50 per bushel than the market falling by another $.50 per bushel.

End line users of corn have been stocking up on futures contracts with abandon. This is another good way of determining the underlying value of a market. The Commodity Futures Trading Commission issues it Commitment of Traders Report every week. The report tracks the market’s largest traders and categorizes them according their type of trading. Primarily, we look at three groups of traders – speculators, index funds and finally, commercial traders. We focus on the commercial trader category. It is our belief that those who produce the good and those who sell the good have the best understanding of a market’s value. Farmers, as a collective, ought to know what a fair price is for the corn they’re growing just as cereal producers or, cattle feeders should know what a fair price to pay is. End line commercial traders have built up a record position on the market’s decline. Clearly, they are willing to lock in as much of their future input needs as they’re bank accounts and storage facilities will afford them.

End line users of corn understand that even if we do end up with record acreage and good yields, we’ll still barely budge the global ending stocks number. The world currently stands at about 70 day’s worth of grain supplies. This is not just corn but an index tracked by AgriMoney that includes rice and wheat. The point of the chart published by AgriMoney is that peak production relative consumption has shifted to a deficit trend over the last 20 years. It has dwindled from 130 day’s supply in the mid 1980’s to our current level of 70 days. All things considered, this year’s US harvest could add about four days to the world’s supplies. This is hardly a drop in the bucket.

There’s no question that corn prices have been declining since the June 28th USDA acreage report and the next major report isn’t due out until August 12th. This leaves the market with time to trade its way through pollination and the trend to continue lower. However, the record net short position in managed money cannot continue to profit from corn’s decline for much longer. The market can only trade so low relative to its fundamental value. Commercial traders clearly see this market entering their value area. We’ll side with them and be on the lookout for a reversal in prices. Most importantly, we’re approaching prices that leave no more room for bearish surprises, therefore, the path of least resistance will soon turn higher.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Third Stage Growth in Agri-Business

The run up in food prices this year has, hopefully, shined a bright light on the oligopoly that controls the world’s grain markets. An oligopoly is a market that is controlled by a small number of producers, which allows them to collaborate and set prices for the market as a whole. OPEC is the most common textbook example. The U.S., Brazil, Argentina and Australia dominate the grain industry. There is grain production in every country but these four control the vast majority of the export market. That may be about to change and bring new, long-term investment possibilities with it.

When crude oil topped $145 per barrel in 2008 it was a painful, but simple adjustment to the world’s lifestyle. When the grain market soared to all time highs this summer, forcing food inflation on the world’s population, the adjustments weren’t so simple. The mechanization of the global grain production process places more and more of the world’s food production in the hands of fewer and fewer people.

The global grain stores are running at multi year lows, just as they were at the beginning of this U.S. growing season. This summer’s drought was the worst in 50 years here. The weather pattern also knocked 13% off of Australia’s wheat crop and they’re the world’s largest wheat exporter. This also led to a nearly 60% decline in their ending stocks over the last three years. The only thing keeping prices in check at the moment is South America’s increasing efficiency. Brazil’s soy production may surpass the U.S. this year and thanks to their long growing season, double crops of corn are becoming normal.

The global demand growth for coarse grain production has been fueled by the Pacific Rim’s meat production industry, rather than by population growth. China’s population growth is less than one percent per year, yet their hog market is growing by an average of 3.5% per year. The growth in their agricultural markets for both grains and meats has been astounding, as production of both have shifted from individual farmers on their own land to the mechanized version of agri-business that is the model of the industrial world. Their soybean imports, which are used for feed, have grown from 3 million metric tons in 1997 to approximately 56 million tons this year.

These wheels have been set in motion and will not be derailed by a collapse in the Eurozone or a surprise in our elections. The trends in population growth and the move towards global improvements in diet are really just beginning. The United Nations and the Food and Agriculture Organization (FAO) just reported that global wheat prices for 2012 were up 25%. They added further that source inputs have now caused the price of dairy to rise by 7% in just the last month.

The arguments over who gets their principal back on a Greek or Spanish Bond is far less important to Greeks and Italians than the ability to put food on the table. Food inflation, as a result of the commodity rallies of ’07 and ’12, was also a primary cause of the Arab Spring. It is far easier to control a population with a full belly than it is to placate a parent unable to stop the crying of a hungry child.

So, where’s the trade? The trade starts with slowing global growth and negative growth across Europe. Negative growth will increasingly put the pinch on Eastern European countries like Kazakhstan, Ukraine and Russia. This is the main breadbasket of Europe and North Africa. Bottom up analysis of these macro trends reveals very large growth potential in several African countries. The BRIC’s have received most of the attention over the last ten years and rightfully so. However, as more and more resources are pulled from African countries for global production, it becomes clear that these countries are also next on the open borders list to develop.

Therefore, using the pending global economic contraction as the setup, I’ll be using declines in the stock market to knock the valuations of agri-business stocks like ADM, Monsanto, Cargill, AgroSA, Bunge, Caterpillar, DeutzAG, down and for retail investors to get washed out. There are two important things to take away from this. First of all, I am not a stockbroker. These trades cannot be executed through me. I stand to gain nothing financially from anyone following this advice. Secondly, I believe that we will get an equity selloff similar to 2008 and I plan on being ready to put cash to work in companies that stand to profit the most from the commodity markets I know best in the coming decade.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Sugar Based Ethanol Boost

Many markets, both commodities and equities declined substantially during the month of May. Two weeks ago, we mentioned that we were nearing fundamental value areas in certain markets. This week, we’ll make the case for a bottoming sugar market as well as its effect on the coming corn crop’s prices.

First, lets review the global ethanol market. The ethanol here in the U.S. is made from corn and the finished product is, “anhydrous ethanol.” Anhydrous ethanol is blended with gasoline. The end result is E85 at the pump. E85 is the maximum ethanol blend allowed. It consists of 85% ethanol and 15% gasoline. The typical ethanol blend here in the U.S. is up to 10% ethanol and 90% standard gasoline. The mixture of E15, which will boost ethanol content to 15% was just approved in 2010 for car models 2007 and newer.

The primary source of ethanol on the open market is made from sugar cane. Brazil is the world’s largest sugar producer and is responsible for about one third of global production. Brazil’s sugar cane derived ethanol is a much more efficient process both in terms of the finished ethanol and product cycle regeneration. Brazilian ethanol production also produces, “hydrous” ethanol. Hydrous ethanol is used in 100% ethanol fueled vehicles, which we see as E100 as well as any Flex-Fueled vehicle.

Ethanol production from sugar cane is much more efficient than production from corn. Ethanol production from sugar produces about 5,166 liters per acre while production from an acre of corn yields only 1,894 liters. The self-sufficient energy mandate that has been the guiding force here in the U.S. for the last 10 years or so has allocated nearly 35% of this year’s corn crop to the production of ethanol. So, why are we basing our future on such an unfeasible model? The answer lies in the government subsidies going to the farm and energy industries. This year marks the end of the $.45 per gallon ethanol subsidy as well as the end of the $.54 tariff we impose on ethanol imports. This combination fostered the proliferation of business entities whose primary profit center was the exploitation of a protected and subsidized market to the tune of $.99 per gallon.

Both of these policies expired at the end of 2012. The price swing of nearly $1 per gallon made U.S. subsidized ethanol inventories a bargain on the open market. Ironically, this led to Brazil being the number one importer of corn based, U.S. ethanol on the global market. Our subsidized production paid for by the taxpayers was sold at the discounted price to Brazil by the blending stations earning the tax credits.  It is important to note that further corn subsidies also exist here to the tune of $3.5 billion to corn farmers in the U.S. and $0 subsidies to U.S. sugar cane growers.

The loss of the ethanol subsidy combined with the remaining direct government subsidies for growing corn should shift total global production of ethanol from corn to sugar. The interesting point will be how many corn based ethanol plants here in the U.S. go the way of Solyndra as the poster children of a misdirected governmentally mandated and subsidized pipe dream. Meanwhile, excess sugar production over the current growing season should be digested, as it is shipped world wide for foodstuffs while Brazil works through their own domestic surplus. This shift will allow the largest corn crop ever planted to be diverted to traditional uses. Furthermore, we can track the huge imbalance in the sugar market between commercial trader and the small speculators through the Commitment of Traders Report. The net effect will be falling corn prices, perhaps under $5 per bushel and a sugar price base around $.185 per pound.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Wheat and Corn Spread at 25 Year Highs

There are prices we accept in life as absolutes. We accept
that gold is more expensive than silver or that a Mercedes is more than a
Chevrolet. Sometimes, things change. Remember when diesel fuel was cheaper than
gasoline? Not only is diesel more expensive, it has maintained its premium for
more than ten years now. Recently, another market relationship has been called
into question – the relationship between corn and wheat.

Historically, wheat futures trade at a premium to corn
futures. In fact, over the last 40 years, there are only about ten periods
where corn closed at a higher price than wheat. Going through 15,000 days worth
of data, I found that there were a total of 56 trading sessions that corn
closed at a higher price than wheat. This is .0037% of the time. Nineteen of
these closes have occurred this year and fifteen came in 1984. There have been
no instances of this for more than 25 years.

The typical eyeball range for the spread is around $1.50.
Wheat is normally worth about $1.50 more per bushel than corn. The widest this
spread has been is $7.15 in March of 2008. The recent peak was in August of
last year at $3.82. Conversely, when this spread has gone the other way, as it
is currently sitting, the widest we’ve seen it was corn trading $.40 cents over
wheat last month.

I went back through the USDA Acreage and Crop Production
reports from the periods when this spread went negative and found some
similarities between 1984 and 2011. The carry out stocks for the new crop years
were exceptionally tight in both cases. The carry out stocks at the end of the
1983 crop year were lower due to two factors. First of all, fewer acres were
planted in 1983 due to governmentally implemented acreage reduction programs
following record production in 1982. Secondly, crops in 1984 experienced severe
drought conditions, which led to the second smallest harvest in history. In
fact, the 1984 harvest ended up being 49% lower than 1983’s.

We started 2011 back at the same record low stocks to usage
ratio we were at 25 years ago. This year, the governmentally sponsored ethanol
production intends to take 40% of the 2011 crop off of the market and we have
had lousy planting weather on top of that. Combining governmentally driven
demand and lousy weather we begin to see the similarities between the 1984 and
2011 crop years.

The corn and wheat contracts for September delivery are still
trading back and forth of even money. The trading idea is to sell corn at a
higher price than we buy wheat. This strategy will profit as these two markets
return to a more normal trading relationship and wheat begins to rebuild its
premium over corn. This spread has recently traded as far as $.33 cents towards
corn over wheat at the end of June. The highest it has been is $.40.

Calculating the trade on a cash basis, we can determine our
trading parameters. Forty cents is equal to $2,000 per spread position in risk
to a trading account’s value. Conversely, a quick reversion to the spread’s
normal range of $1.00 to $1.50 in wheat over corn would equal a cash value of
$5,000 to $7,500 in trading account profits per spread position. However, as
with the diesel fuel to regular unleaded example, it’s possible that these
market relationships can shift from anomaly to a new normal. Therefore, risk
must always be the first consideration when deciding whether or not a trade is
suitable for your account.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

 

Trading the Tsunami

The earthquake and tsunami in Japan are tragic and I don’t want to minimize the human devastation, loss and ongoing fear. However, it’s my job to try and explain how this has affected the markets and what I believe is yet to come. The markets’ initial reaction to outside shocks is based on its participants’ fear. The market sells off due to uncertainty. If you or I had direct investments in Japan, we would want to get out and convert to cash while we waited to see how things unfolded. It’s human nature to retreat to a defensive position when confronted with disaster, whether financial, physical or emotional. Japan’s stock market sold off 16% in two days.

The specifics of the disaster in Japan are tied to demand destruction. Japan imports nearly everything it needs to run. The disaster has massively cut imports. Petroleum products, food, manufacturing raw materials and more have slowed to a crawl. Australia is one of Japan’s primary import sources and Australia is an export driven economy.  As a result of this, the Australian Dollar declined nearly 3% immediately.

The other major component of demand destruction lies in Japan’s 30 years of dominance in the manufacturing sector. Japan no longer has the competitive advantage it once held in technology over the rest of Asia or, the labor advantage that it held over the United States. There is a great degree of uncertainty regarding which manufacturing facilities will be rebuilt and which will simply be relocated elsewhere in the world. Japan has lost a large share of its competitive advantages.

The massive mobilization involved in the rescue efforts combined with the destruction of Japan’s refineries and nuclear reactors will squeeze global petroleum supplies. I expect Japan to begin importing large amounts of refined petroleum products from the west coast of the United States. Our refineries are running around 85% of capacity, our crude storage tanks are nearly full and our trade relations with Japan are already in place. China’s Sichuan earthquake in May of 2008 killed 68,000 people and left nearly 5 million homeless. The scale of the military operations required to rescue people and stabilize the infrastructure pushed crude $20 higher per barrel in less than a month. Approximately 430,00 people have been relocated in Japan, thus far.

Once the people are safe, they’ll need to be fed. Every piece of food near the damaged areas will have spoiled. The growing radiation fears are already making their way into the food chain. Japanese people are afraid to consume food that may have been tainted. This will place a large strain on current grain and meat supplies. Current grain and meat stocks cannot be increased. Our inventories are what they are. Fixed supply plus greater demand means rising grain and food prices are on their way. Live cattle prices climbed more than 20% immediately following the ’03 blackout and power was only out from 4-8 hours. Obviously, the length of the outage is much greater in Japan while the population base is smaller. We’ll need more data to quantifiably compare the two.

The reconstruction process is the final phase to discuss. Financing the reconstruction will be difficult on Japan’s ailing economy; in fact this topic deserves its own article. Heavy equipment companies like Caterpillar and John Deere have already attracted some attention. Oil refinery companies will also benefit. Nuclear reactor technology is a short term negative as General electric has taken a hit even though Japan may rebuild their reactors. Commodity prices will rise as Japan re-stocks and this will be evident in meat and grain prices. Copper and steel will also see increased demand. The wild card in the reconstruction process is natural gas. The radiation scare may be enough to push the political conversation of natural gas to the front burner.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Perhaps We’ve Gotten Ahead of Ourselves

Commodity Prices have been on a tear. No question about it. Gold has traded over $1,300 per ounce and silver is over $21 an ounce. The grain markets have seen huge gains in corn, beans, rice and oats. Even markets like coffee, orange juice and cotton have participated in the broad commodity rally. Does this mean it’s a good time to put more money in commodities? Not necessarily. This is where our philosophy diverges from stockbrokers. We don’t generate revenues for the firm based on equity under management. Therefore, our best business practice is to provide our individual traders with information that will help them be successful over the long term.

The commodity markets as a whole, have built this rally on the economically sound principals of inflation, which include a declining dollar and low interest rates. However, according to the data that I’ve been watching, it’s quite possible that we’ve gotten a bit ahead of ourselves in the economic cycle. At this point, the anticipation may be greater than the event.

Starting with the big picture. There is a third component to inflation that hasn’t gotten much press over the last year and that is, velocity. Velocity in economics is how quickly money is changing hands. The higher the velocity of a dollar and the more it circulates, the more action there is in the economy and the closer we are to potential inflation. What we’ve seen since the economic crisis began and the housing bubble collapsed is that the Federal Reserve Board has flooded the economic system with Dollars.

The adjusted monetary base of the United States has increased nearly 25% since September of 2008. Broadly speaking, this means there are 25% more dollars in our pockets and in our checking, savings and cd accounts at the bank. However, as I wrote last week, Americans are finally starting to save their money. This is why the velocity of money has declined by more than 17% since the economic crisis began in 2008. This is in spite of the Federal Reserve Boards attempts to stimulate spending.

The United States is the financial trading center of the world. We have the most mature stock and commodity exchanges. They are the most highly regulated and also the most liquid. Therefore, we are the hub of the global financial network. The commodity markets here in the U.S. service 40% of all traded commodities. Therefore, the prices of commodities traded here in the U.S. actually reflect a global view of fair value. The decline in the U.S. Dollar has made trading prices in the U.S. seem like the latest sale at Kroger, just bring in your Treasury coupon for double points.

Finally, in the weekly Commitments of Traders Reports, we have seen a very large build up of large speculator and commodity index trader long positions with the commercial traders increasing their short positions as the markets have climbed. The fact that many of these markets are significantly below their pre financial market collapse highs of early 2008 is a telltale sign that the current market rallies may be over extended. It’s important to note that the two groups supporting the commodity markets have no ties to fundamental value. The large traders are simply trend followers. They are willing to be long or short any market at any time. The commodity index traders are only allowed to purchase commodity contracts to keep their portfolios properly weighted. They will add positions as the market climbs and offset positions as needed on a market decline.

Commercial traders are the producers or, end line consumers of the actual commodities themselves. They are keyed into the entire production mechanism and have a keen understanding of the issues affecting their markets. The general theme I see building is that they believe many of these markets are substantially overbought and inflation is further away than we think. While they do believe there is inflation coming down the pipeline, they believe it is further off than the commodity markets are making it look. They have bought up large positions in short term Treasuries while taking a decidedly more bearish tone towards the long end of the yield curve. In fact, the commercial trader net position in the 30 year bond is the most bearish it’s been since 2005, prompting me to consider taking profits in our bond trade from several weeks ago.

The combination of an economy flooded with cash led many investors to anticipate inflation down the road, which makes commodities a very sensible place to put money. However, given America’s newfound desire to save, the flood of cash hasn’t quite had the textbook multiplier effect that was expected to increase GDP 50% for every dollar spent by the government. Given the over extended state of some markets combined with fundamental data supporting declining velocity, it may be a good time to adjust risk in the commodity markets.  Velocity will increase and repurchasing commodities on a pullback could be an effective strategy once the actual race finally gets going.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.