Our theme continues, the Treasury Bond market spreads will set the tone for 2016. We wrote here at Equities.com on January 5th that, “US Bond Little Changed in Spite of Chaos.” The chaos has certainly continued with the S&P 500 off nearly 5% since then and China’s issues are anything but settled. It’s not very often that the workings of the global economy can be examined in real-time through the lens of a daily chart. We think the congestion in the U.S. interest rate markets is providing us with this rare opportunity as we speak and that its forecasting abilities could set the tone for the rest of the year.
The recent weeks of hot weather have begun to take their toll on the crops in the field. Primarily, we are witnessing soybean’s greater sensitivity to late summer heat relative to corn. Not surprisingly, soybeans have rallied about 14% since August 8th as compared to less than 3% for corn. The result of this divergent behavior among crops grown side-by-side is that the bean to corn ratio has been elevated to levels that we don’t view as sustainable. Therefore, we’ll look at some reference points for the bean to corn ratio as well as the relationship between these two crops before ending with some fundamental data that forces us to re-think the usefulness of historical data in the face of a fundamentally changing marketplace.
The bean to corn ratio is simply the price of soybeans divided by the price of corn. Currently, November soybean futures are trading around $13.55 per bushel and December corn futures are trading at $4.68 per bushel. The November and December futures contracts represent this year’s crop in the fields, respectively. Therefore, the current bean to corn ratio is approximately 2.9. Beans are 2.9 times more expensive than corn on a per bushel basis. The last time this spread was this high was August of 2009. There have only been four years since 1975 when ending prices for the current year’s crop have closed at a spread greater than 3. According to Carl Zulauf of Ohio State’s Department of Agriculture, the maximum traded price for the ratio is 4.1 in May of 1977. He’s also published the low figure of 1.72 in July of 1996. The average for the spread over the last 45 years is 2.52 while the spread’s normal trading range is 2.19 – 2.85.
Soybeans and corn obviously share many of the same concerns throughout the year and therefore their prices tend to move in the same general directions. Their seasonal characteristics are very highly correlated with the lone notable difference being soybeans’ tendency to remain at higher prices later into the spring due to their later planting dates and associated concerns. Once beans get past July 4th, they sell off just like corn until harvest time nears at which point they both get another boost. The correlation between beans and corn has been positive on a weekly basis all the way back to November of 2012. The daily chart, on the other hand is currently displaying the first negative correlation between these two markets since early May of this year which coincides with typical planting issues.
The United States is still the dominant market maker in both corn and soybeans. However, the rapid expansion of Argentina and Brazil’s commercial farming industry is changing the dynamic of the global corn and soybean markets. This year, the combined output of Argentina and Brazil is likely to be nearly 30% of global corn production and as much as 60% of global soybean production. The combined soybean output of Argentina and Brazil is expected to outpace the US by a third. This must change the way we view the data at hand. This is especially true when studies are produced using 45 years worth of data as the Ohio State piece referenced. The global supply of beans and corn hasn’t been split among our countries. The process has been and will continue to be, additive. Total global production will continue to increase overall with foreign production continuing to grow faster than domestic production.
The marketplace always reflects the participants’ best guess of fair value at the last traded price. Therefore, both domestic and global production rates are considered when trades are placed at the US commodity exchanges. However, more weight is always given to prices in the larger context. Daily highs and lows matter more than those of the last minute just as weekly highs and lows are accorded greater importance than their daily counterparts. Therefore, when markets make multi week, monthly or yearly highs or lows, we pay attention. The soybean rally brings us to levels not seen since last December and has pushed the relationship between corn and soybeans to multi-year highs.
We believe that the latest push in this spread has come from speculative buying in the soybean market. There are three primary drivers of mass speculative action in the commodity markets, all of which lead to whipsaw action at extreme price levels. Tension in the Middle East spurs speculative energy buying. Stock market collapses spur knee jerk selling. Finally, droughts spur speculative corn and bean buying. All three of these situations end up with small speculators left holding the hot potato. The current Commitment of Traders report clearly shows large amounts of small speculative buying heading into the USDA Supply/Demand and Crop Production reports. Considering commercial traders have pared their net position by 25% over the last three weeks, we believe it’s likely that this report could mark the high for the bean corn spread as it returns to its normal trading range.