Monthly Report Archive
October 4, 2016
December corn – up 21.25 cents (6.74%)
November soybeans – up 11 cents (1.17%)
December wheat – up 13.75 cents (3.54%)
Corn rebounded in September from the multi-year lows posted at the end of August. Leading into this period, hedge funds were very short corn and long soybeans. This contraction of the corn-soybean ratio could have been a product of funds lifting positions to end the quarter.
November 2016 soybeans / December 2016 corn. (Ratio fell from 2.99 August 31st to 2.83 September 30th)
Yields are going to be everything going forward. As of Sunday, the USDA is reporting corn harvest at 24% complete. With 2/3rds of harvest to go, there is still more to know about the crop size. Price action could be very different if the national average yield swings +/- 4 bushels from the current USDA estimate of 174.7.
We don’t pretend to know the final crop size better than the USDA. The September WASDE estimate was composed of over 1900 samples and is the most qualified estimate the market has. The next WASDE report won’t be released until October 12th. Anecdotal yield reports have been very positive and support the USDA production estimates. Given that, we believe total supply will be 16.871 billion bushels, a record by 1.392 billion!
When the USDA has this large of a supply, they naturally forecast a record demand. This year they have projected 14.475 billion bushels of use, leaving a carryout of 2.384 billion. While this carryout is possible, we believe it is not likely unless price action works to incentivize this extra demand. It doesn’t show up just because the supply is available, it has to work to achieve it.
The USDA demand forecast is 727 million bushels above the previous record. Ethanol accounts for only 75 million bushels of that projected increase. So where is the other 652 million bushels of extra demand going to come from? The USDA assumes an (extra) 361 million of feed demand (corn only), 308 million more in exports and 8 million in other FSI. We are going to break down these two categories to explain why we think this is an uphill battle.
For this example we are going to group corn feeding with wheat feeding. This is because they are in direction competition with each other, and the USDA has forecasted a 195 million bushel increase in wheat feeding in 2016/2017 due to the supply excess. That should naturally compete with the total corn feed usage. Between these categories, demand has remained flat for the last three years. The USDA is projecting a 10.43% increase in total domestic feeding from 2014.
The feeding is up double digits while total livestock head is up by only 5% in that time frame.
And the feed ratio per head is the highest estimate going back to 06/07.
Since feed demand has remained flat for the last 3 years and even declined in 2015, we find it hard for a double digit feed increase in 2016 to occur without a large, sustained price incentive.
The USDA is expecting export demand to be up 308 million bushels from 2014 when we had record total demand. For the same reasons that we believe the current feed usage estimates will be difficult to achieve, we are skeptical that the USDA export demand estimate is probable as well. The world is flush with cheap, feed grade wheat in direct competition with corn. The following chart shows record world wheat supplies and the highest stocks-use ratio in 15 years.
Not only are global supplies a record, they have also been having a lot of quality issues as well. A large portion of European wheat is not of milling quality and will therefore replace some of their corn feed needs. Black Sea feed grade wheat is also very abundant. These will all impact the ability for US corn to stay competitive in the global feed market, perhaps forcing corn prices lower in the process.
While wheat stocks are ultra-large around the world, corn stocks are also a heavy burden. The following chart shows non-US held corn stocks for September 1st. The bottom line is that the world already has too much corn and they will not likely be importing excess US corn unless the price is right.
GOVERNMENT POLICY WILL IMPACT SUPPLY/DEMAND
China is in the middle of a major shift in their support program for producers. For years they have been supporting the flat price of corn as the primary subsidy for their growers. That has resulted in the unintended consequences of large corn equivalent imports and severely burdensome government stockpiles. They have recently increased the tariff on US DDG imports by over 10% which should curb this (and probably result in a reduction of US DDG exports). They are also taking steps to export some of their corn to state-owned companies that are offshore. By reducing the price support program, they will make the corn vs meal spread more in-line with where the actual free-market. This will naturally shift the feed mix away from artificially high meal levels to a meal-corn ratio in-line with the rest of the south-eastern Asian countries. This should help them burn through some of their corn supply, but it also may impact how much soy and soymeal they need to import
In Argentina, the new president Mauricio Macri has eliminated the corn and wheat export tariffs. However, due to falling reserves, they have had to delay the drop in the 30% soybean export tariff until 2018. This was an unscheduled delay and may artificially push more producers to plant corn and wheat than they may have otherwise. We will need to monitor both of these situations as time goes on.
Soybeans didn’t experience the same strength as corn had during the month of September. This could be due to the fact that soybeans haven’t carried the same sell pressure from the investment community coming into this period. Soybean yields have also been very strong, likely on account of the wet August. In September the USDA raised their soybean yield estimate from 48.9 to 50.6. Recently, FC stone estimated soybean yield at 52.5! We are going to stick with the USDA yield for our current projections and consider that as the conservative approach.
Even with the stronger yields, there seems to be a broad opinion in the market that China is just going to buy whatever the US grows. As a result, it is assumed that US carryout will be tight (and that prices will rise). For the reasons related to the Chinese corn policy we disagree. At some point the market has already priced this demand in and we think this has already been achieved. The record-high 2017 corn-soybean ratio (for this point in the year) incentivizes many producers around the globe to plant more soybeans. That call to action is already happening which is why we have been more aggressive on 2017 soybean hedging recently. If Chinese demand remains flat next year, we could see a major dip in prices and it may be that soybeans are carrying more price risk than corn.
In addition, corn storage pays more (currently) when figuring the cost of money into the equation. The basis increase would need to be very large for soybean storage to cover the cost of current futures spreads and the cost of money at 4% interest (average loan rate). At a time when soybean piles are mounting and cash needs are high, soy sell pressure could be large through the end of harvest. We still see downside risk at these prices and would remain well hedged.
For wheat, there isn’t much to talk about that hasn’t already been covered. The bottom line is that wheat stocks are overly burdensome to the point that we recently made 10 year lows. This may mean wheat is closer to a bottom than corn and soybeans since the market has already priced in the abundant stocks. Investment has been very short and acres have also fallen as a result of the price action.
Still producers are incentivized to sell forward due to the tremendous cost of carry in wheat futures. The cost of storage is so high because of the large supply as well as the Variable Storage Rate (VSR). The VSR pushes the spreads beyond what normal market forces would offer. This is an attempt to force futures to be more in-line with the local cash markets (forced convergence). But for producers to go un-hedged, they give up that chance to capture the cost-of-carry which is well beyond what you could get in any other low risk investment (meaning sell forward a year out at a % premium above what other investments would return). So for now we just want to be adequately hedged in wheat and find ways to sell puts and buy call-spreads for those who want upside potential.
The next WASDE report will be released on October 12th. We look forward to seeing the latest USDA yield estimates to update our projections. For now, we want to use this recent strength to catch up on sales for those extra bushels you may have. Revenue is PRICE x YIELD, and profits in 2016 will likely hinge on the record yields projected. The last time corn had this large of a stocks-use carryout was the last time corn futures were below $2.50.Wheat has touched the 10 year lows, why couldn’t corn do the same? As insurance expires, a large portion of bushels will no longer be protected with the government put option. A decline starting in mid October (as it did in 2015) would be a problem development for many US producers. For 2017 corn, the price is currently hovering around $3.86, which is exactly where 2016 corn was last spring. At the time, corn and soybean acres gained ground and were a combined record! The market’s job should be to reduce acres in 2017, at what price does that happen? We just want to make sure everyone has enough coverage to protect that revenue . Please call us if you have any questions or would like to get a plan in place for after harvest. Have a great October!
August 29, 2016
For the month of August, corn is down 22 cents and has touched a new low dating back to 2009. This is happening in the wake of favorable yield estimates by both the USDA and Pro-Farmer. Either way, it is presumable that a record crop is coming which shifts all of the focus away from production and puts the spotlight on demand.
The most recent WASDE report was released in August. With the added production, the USDA added another 300 million bushels onto their already inflated demand estimate. The USDA believes that the market will do its job to find that demand, and it will likely have to do it with lower prices. We have argued the same point, though we have been saying that the market is going to have to get very low for an extended period of time. It will be especially hard to get that extra demand because the ethanol market has matured and is capped by the blend wall. The table below shows the year-over-year demand change for FSI (which is mostly ethanol).
Given the maturing ethanol market, most of the extra demand NEEDED this year will have to come from exports and feed/residual. The last time we saw a demand increase to this magnitude from these categories was 1979. Furthermore, the world is loaded with cheap feed wheat, so is it likely for corn to find this demand without trading at a severe discount.
Given the demand setup and large acreage, the response to small yield fluctuations by the USDA could be minimal. The demand is going to be satisfied which means the pressure for the current USDA yield estimate to hold is small.
POOR MARKET SETUP
While the demand setup is a problem because we could reach “peak” corn demand and still have a large carryout a larger problem is emerging… the market setup. Cheap money has allowed high leverage and debt to grow. In many cases producers have rolled forward operating debt with a “restructuring” loan, turning it into a 5-year note. This has raised their costs and has created an unsustainable situation. With the lower prices, many producers may be running into cash flow problems. When this happens, voluntary marketing for a margin turns into need-based marketing to raise cash. It is within these circumstances when markets see large, extended declines.
There are a lot of parallels between this and the energy markets. Crude oil fell for two years, from above $100 down to a low of $26.05 per barrel. It came along after a rise in production and excess supply, just as corn has. Part of the reason for this substantial drop was debt and infrastructure. Cheap interest rates along with strong demand created the infrastructure and production… but the record industry debt kept oil producers selling even as the price declined. This was in order to raise capital for debt servicing… even when they believed the price was too cheap. This is partly due to the unintended consequences of zero interest rate policy.
We believe the tides are changing within the Ag Industry, with rumblings of a major bank overhaul on the way. The problem is systemic and it goes to the heart of how the industry manages farm revenue. Since the banks are the lifelines of many operations and take on some risk in the process, the changes would likely start there. They may end up adapting to take on a different roll from the current status quo… requiring some income protecting benchmarks tied to their loans (other than just crop insurance).
The bottom line is that there is enough corn around to satisfy demand in the midst of a major cash crunch. We see this within the futures markets in many situations. When a bad trade is on, it takes a while for the market to clean itself before it can reverse and go the other way. In this case it is all of the unsold bushels that will need to be sold to raise capital in the coming months. In our opinion a sustained corn rally will be very difficult until these bushels have been sold.
SUPPLY AND DEMAND
Notice we have yield pegged at 172. Like everyone else we don’t have the resources to judge final crop size like NASS does. We have a better idea of what demand is capable of based on historicals. Even with using a reduced yield from what the USDA has and using a record demand by 305 million bushels, our carryout estimate is still 2.690 billion! We think that is within range of peak US corn demand for this period and the risk is if the USDA’s final yield comes in above 172. Any further increases to US corn yield could just get tacked onto final US carryout.
November soybeans are down 38.75 cents during the month of August. Like corn, soybeans fall under that row-crop category which is currently in a cash crunch. This puts downward pressure on prices as soybeans are sold at the market to raise capital. Beans are in a slightly different situation than corn however. Soy export demand makes up a larger portion of total demand, and export demand is up. Early purchases for new crop soybeans are well above where they were at this time last year. China is proving to be a price buyer once again, especially after Brazil started lowering its 15/16 estimate. However, the early purchases are still well below where they were at this point just a few years ago and some private estimates have China importing 5 million MTs less than the USDA does. This could mean 300-400 million bushels less than expected. With some of the acreage shuffles in South America this year, they could also pick up a larger share of Chinese imports anyway. In our demand estimates below we see exports at the higher end of where they should be and could end up coming in less, raising carryout in the process.
Another concern is that the corn-bean ratio has remained high, so the incentive to plant soybeans is already there for future years. This will keep forward production high, especially in the South American countries. We see this as an ongoing risk for soybeans.
Even though production is estimated at a record, price fluctuations may be a little more responsive to yield changes by the USDA. Weather has remained favorable throughout August and pod counts are high. By all accounts we are expecting a record large crop, price direction just depends on how large. At AgYield we are expecting to see a national average yield above 50 bpa and could see beans easily fall below $9.00 in that case. However if that is wrong the marketing plan needs to have a balanced approach, which we believe we have accomplished. With 100% protected and half of it bought back in the May $11 calls, we can still participate in a rally if South America has a problem this winter. The following chart sums up why beans could eventually have a story for strength, and why they are currently holding a huge premium to corn compared to that ratio’s history. Production continues to rise to an all-time record high yet final carryout is still projected below 10% of use (USDA’s estimate).
If yield were to rise to 50 bushels per acre and we backed off demand to only be 66 million above the previous record instead of 127 million, stocks-use would jump to 13.75%, the highest since 2008/2009. This is why we want to be 100% sold.
SUPPLY AND DEMAND
Wheat is currently in panic mode. For the month of August wheat is down 38.75 cents, most of which has been lost in the last 2 trading sessions. Wheat is now down to the lowest price in 10 years. This is the harsh reality for wheat, too much supply. It is also an example of what can happen to corn, an acceleration as we get lower. Once the September wheat contract broke $4.00 it was off to the races. This setback is also coming after most of the Federal crop insurance revenue policies have expired.
The wheat market knew it had a supply problem a long time ago. Acres fell dramatically from 2015 and the market is still oversupplied. This is the problem with maturing markets, demand can be sticky meaning it takes a long time to burn through the excess. World wheat was in short supply 9 years ago and it has since risen to meet the world demand. The pendulum has swung the other way and prices are down as a result.
The best way to market wheat right now is to continue to use the comparative advantage of storage and push the sales out as far as possible. The current September (SRW) contract is $3.7050 but the September 2017 futures are at $4.6125, representing a 24.49% cost-cost-of carry. This is why funds want to be short wheat, that cost of carry is a huge advantage for the shorts.
SUPPLY AND DEMAND
The USDA raised the wheat yield in the August report, and also raised feed demand another 10%. Based on where cash wheat prices have been trading to corn that makes sense, but this is also what is going to make the USDA corn feed demand estimate extremely hard to achieve. That is another 200 million bushels of wheat fed more than last year, yet they think corn feed usage is also going to be up 475 million year-over-year? That is unlikely unless prices are exceptionally cheap.
Many analysts continue to assure producers that the bottom is in and that no more price risk exists. Many of those same analysts have been bullish all summer. The thing to remember is that nobody knows where the market is going because nobody can accurately discount all of the relative information the market has to price in. Information such as weather, currency fluctuations, government policy, export demand etc. We cannot predict and certainly cannot control these factors. However we can control marketing and margins in different yield and price situations. For those who believe the lows are in and want to cover hedges, examine your risk if prices continue the decline. We advocate staying with the current hedge recommendations for now, unless you are in an insurance payment for corn. A price rally doesn’t hurt the most amount of people, an extended decline does. Please give us a call if you have any questions or to get caught up with our current strategies.
July 21, 2016
In the last 5 weeks, wheat and corn are down over a $1.00 while soybeans are down over $1.50. Why exactly? The same could have been asked for why they were up there in the first place? World wheat carryout is projected at 15 year highs. Corn carryout is the highest in over a decade and forward production estimates are elevated due to political changes in South America. Rampant speculation surrounding the “La Nina drought” drove corn to $4.49 and now the market has taken that weather premium out and is actually doing it’s job to go find demand.
In the May and June monthly letters we talked about how the funds were “bullish until proven wrong,” and that is exactly what happened. The ultra large world grain situation has caused the funds to liquidate longs and many of them are even getting net short. This is exactly what they should be doing given the strong dollar, record unsold position in the field, and highest carryout projection on record.
After the massive corn liquidation, many analysts and traders are citing that as a reason for corn to carve out a bottom. We however believe plenty of downside risk still exists and a sub $3.00 looks like a target. The funds are just as capable of getting short as they were going long. Both funds and farmers could be trading on the sell side.
If the funds decide to go short they have the ability to stay that way for a very long time. Take wheat for example, they have been short wheat for over 12 months running:
Wheat and corn are an anchor to each other. The managed money has a lot of room to keep building corn shorts. Given a normal cost-of-carry a short position is easier to hold for a long period of time than a long position. This is because every roll is buying the cheaper month and selling the more expensive one.
For soybeans the funds are still holding a large net long position. This could be the right play, we just need to see what weather does in August. The point is we don’t know how beans are going to finish this year. If they don’t have a weather event however they could have a similar move to what corn had. We aren’t ruling out sub $8.50!
Our 2016 supply and demand estimates for corn highlight why we believe corn has the potential to test $3.00 this year. Our total production estimate is at 14.898 billion bushels, which is over 1.29 billion more than last year! We believe our yield estimate is conservative while our demand estimate is aggressive, so there is work to be done to get the carryout BELOW 2.5 billion bushels. Another 300 million bushels of “fluff” has been built into our demand estimates which the market will likely have to work to achieve (meaning lower prices). Our total demand is estimated at 14.150 billion bushels, 405 million above the previous demand record in 2014. We believe this is within 100 million bushels of PEAK DEMAND, meaning any additional yield above 172 on the national average would immediately be added to final carryout. We believe that yield reductions below 172 would be met with an equal reduction in demand for the first 300 – 400 million bushels, so we could see 4-5 bushels per acre lost on the national average yield and still come out with a mega carryout.
And the main reason we think demand is overstated is the increase in wheat feeding. Even the USDA acknowledges wheat feeding is expected to double in 2016/17, however they haven’t discounted any corn feed usage along with that, instead they raised it 200 million from their 2015 estimate. Given the fact that the USDA June 30th corn stocks was 194 million bushels MORE than expected, it is reasonable to assume that even the USDA’s corn feed estimate is overestimated for this year!
To put the corn price in perspective, we need to consider where we were in 2014. At harvest prices got down to $3.18. Today corn is 5.3% higher than this even though we could be facing a carryout 50% larger! In addition to this, the US Dollar index is also 12% higher. Considering these factors corn could easily fall below $3.00 and we think the market is not prepared.
In dollar adjusted terms, corn would have to fall to $2.83 to tie the 2014 low and $2.63 to tie the 2008 panic low! Dollar adjusted means taking the level of the US Dollar Index into consideration at the time that the corn prices were recorded. For example, in 2012 the dollar was extremely weak while corn was above $8.00, so in dollar terms this would bring the price of corn down below $7.00 on this chart to account for that dollar weakness. the same goes for periods of dollar strength. The dollar strength needs to be taken into consideration for how low prices can get. See below for a DOLLAR ADJUSTED corn price chart going back to 2007. This is interesting because this is all during the ethanol boom, which a lot of bulls charge is a reason we can’t fall below $3.00 again. However in 2008, flat price corn was at $2.90.
Soybeans have a tighter supply outlook than corn does. Even with the additional acres and trendline yields the USDA has carryout at only 290 million bushels. Chinese demand will be key. Their appetite for US beans has remained strong but we don’t see the justification for raising 2016/17 export demand by 35 million bushels year-over-year. We also don’t see the reason for raising crush by 125 million bushels, so we are slightly below the USDA’s demand estimate. That raises our own carryout projection to 331 million bushels.
The market still needs to get through August before it is comfortable with projecting an adequate carryout. Crop ratings are extremely favorable going into this time but there are still chances for a yield surprise, in either direction. If there is still a 5 bushel +/- swing from trendline possible, we expect soybean volatility to remain elevated through September. Our approach is simple, 100% protected with 50% upside exposure above $11.00 and a favorable protection price… we still like that position.
The USDA wheat estimates are fairly spot on. They are not being overly conservative with feed demand given the feed margins. We are projecting a 350 million bushel feed demand which is 50 million higher than WASDE, however that won’t likely impact wheat prices any more than the market has already priced in. Considering the ultra-large carryouts, the best way to hedge wheat in our opinion is to sell forward and collect the carry. At some point world wheat supplies need to start declining, but that could take a long time. For US wheat futures to rise, the only foreseeable cause in our opinion is a decline in the currency and change in appetite from US hedge funds.
Another factor for wheat that is rarely discussed is the VSR (Variable Storage Rate). When wheat is within range of full carry, VSR kicks in and allows wheat spreads to trade below full carry to try to force convergence between the cash market and futures. What happens are some very uneconomical things for wheat, but the bottom line is wheat is going to be the best crop to store forward in 2016, hands down. If the market sniffs this out, those who can use their bins for wheat may choose to do so which means more corn forced to the market out of storage. This could put additional pressure on the spreads and basis and is cause for concern for corn bulls.
And like corn, wheat isn’t escaping the US Dollar strength either. Given the size of the wheat carryout, it would have to get down to $3.62 to trade at the dollar adjusted lows from 2009.
If we assume that corn yields are at trend or higher given the weather and crop ratings, we have to assume there is going to be a cash crunch this fall with prices at multi-year lows. This could force farmers into a basis problem as cash is raised and ground piles start to form. Commercial storage rates will skyrocket again and basis will likely widen. We recommend locking in basis for all bushels you are planning to deliver at harvest now to avoid a problem situation. If you plan to store more than 50% of your corn, it may also make sense to start locking basis for Jan – March as well. Please give us a call to discuss.
We see the undersold situation as a liability to price action leading into harvest. Considering the ultra-large grain carryout projections, we wouldn’t leave much to chance. We are moving toward 100% sold for corn and having an additional 25% in $3.50 short-dated puts if the market allows. If you have not yet caught up to our hedge recommendations, please give us a call to see available strategies.
June 8, 2016
The last month was very supportive for grains as hedge funds added heavily to their net long corn and soybean positions. Since our last monthly update on May 10th, December corn has added 49.25 cents, November soybeans are up 82.75 cents, and July Chicago wheat is up 58.25 cents.
As we said in the last monthly report, the funds are “bullish until proven wrong,” and basically nothing new has come to light to change this fact. The US Dollar Index has been turbulent, but is back to basically the same level it was on May 10th. Planting pace resumed and finished at an above average pace in most areas. Crop conditions are at 75% good-to-excellent for corn and 72% for soybeans: both historically high. South American harvest has progressed as expected. While yields have been reported lower in areas of South America, overall crop size estimates aren’t dramatically below month ago levels. What we said before holds true for the moment, the funds are in control. This is great for growers because it allows for better marketing opportunities and we want to continue to take advantage of them as they emerge.
Hedge Fund Activity
Hedge fund activity is probably the largest factor affecting prices in today’s market. It would be hard to quantify where prices would lay without them. For this rally to continue without any weather issues in the US it will almost certainly have to center around hedge fund involvement. The following chart shows the managed money positions vs the price of corn for the last 15 months. It was a fairly weak time for commodities due to the strong dollar. For that reason, the funds were net short for 53% of this time and during this time the price averaged 20 cents less than it did while they were long.
Clearly the market is sensitive to hedge fund positioning as this chart shows. Anyone who has followed the funds could tell you this without having to point it out on a chart. However, the reason we added this was to remind everyone that the funds aren’t always right and last year was a costly lesson for them. The managed money crowd had a fresh record short corn position in early June. This was completely wiped out with a massive short covering rally which peaked on July 13th, 2015. By that date the funds were net long over 200,000 contracts of corn, a position change of 1.687 billion bushels in just under 45 days! We all know what happened after that, corn slumped back to new contract lows as fundamentals took over, as they always do. We are not trying to “predict” the same outcome again because we don’t know what weather will be like this summer. However, we are alluding to the possibility that this rally is not fundamentally driven. The newswires and fundamental “reasons” usually follow price action and are usually already factored into the market. In our opinion the major driver of the rally to this point was money managers putting on massive long positions as they attempt to bottom-pick commodity prices and bet on a weather problem this summer. Whether our assumptions are correct or not we do not care. We continue to base our marketing and strategy advise on profitability and not our opinion. We are at or above the 2-year high range in both corn and soybeans and at a profitable level for most producers. Locking in a floor at these levels and having ample upside price exposure as we head into the June 30th reports and July weather is paramount in our opinion. For low margin call risk and high upside price exposure, a combination of making cash sales and buying May 2017 call spreads has been a good strategy for many producers. Make sure to check with your Advisor and AgYield to make sure that you have a strategy in place that you are comfortable with and provides the right level of downside price protection, capital requirements and upside revenue potential that you are looking for.
Old Crop/New Crop Spreads
Another indication that the funds are heavily involved (aside from the CFTC telling us their net positions), is the amazing spread action. The US carryout levels are not tight by any measure. In fact, they are at multi-year highs. The following chart shows the ending stocks (projected by the USDA) divided by total use.
2015 is a great year for carryout. This is the highest soybean carryout since 2005 and the second highest corn carryout in the last decade. So why exactly are we seeing the spreads act like this:
uly – December corn: July corn is trading at only a 2 cent discount to December, implying very tight supply or extreme demand. However carryout is projected at multi-year highs.
July soybeans got to a 75 cent premium over November, even though they will be the most abundant since 2005
This is just a snapshot of the entire forward curve of these products. In soybeans, it is a complete backwardation market, meaning the closer to delivery, the larger the premium. This could be the market pricing in a larger than expected South American production cut… OR it could just be that the investment crowd flows money into the most liquid contracts (which means front month). Again, it is impossible to quantify the fund money impact but these spread anomalies coincide perfectly with the fund positions.
Part of the reason for the rally was that many in the industry were caught “short” including the large multi-nationals and large spec traders. In hindsight the market that was caught the most short was the soybean complex (and specifically soybean meal) in nearly every sense. The market was short flat price, short spreads, short soybean meal against oil and short on soybean crush. The harvest delays in Argentina combined with the managed money investment into commodities was the catalyst that started a massive short-covering rally that lasted for over 2 months. This rally in the soybean complex spilled over into the corn and to some extent wheat markets, convincing funds to cover shorts and increase long. Many producers, advisors and managed bushel programs were aggressive sellers of soybeans at $9 (and in many cases speculative sellers on top of hedges) only to see prices quickly rise above $10 and now $11/bushel. Because of this, we believe that the same players are trying to make up for their low priced soybean sales by waiting for much higher corn prices. A very risky strategy in our opinion that could result in 2 very bad marketing decisions.
So what now? In our opinion the short “squeeze” is over but the massive fund length and strong looking chart technicals remain as we look at new crop soybeans and corn. Now we are in June and just entering the heart of the growing season. At these prices there is equal risk of a major break or major rally in our opinion. This is why June is a common month for putting in yearly highs as the risk premium is built into the market but a weather problem fails to materialize. We will need new bullish information to continue to support and drive prices higher from here. However, if the weather does turns south, we could see another massive rally even from these levels. You can see in the weekly corn chart below that we are approaching some very interesting levels in the corn market around $4.40/bushel. Trading above this level would be at fresh 2-year highs and look pretty good on a chart for the managed money crowd and combined with a weather problem could easily push prices north of $5.00/bushel. However, without a weather problem we could just as easily see the market top around this level and see prices test the low end of the range of $3.50. Because of so much uncertainty, the volatility should stay very high through August and at many times will be “untradeable”. This is why we are very adamant about aggressive hedges with a lot of upside exposure to carry us through the next 2-3 months. Moving hedges into the cash market when basis levels are decent to free up capital would be a good move in our opinion. Swings in the market are likely to be very large at times and rather emotional. Having a sound strategy in place right now with a gameplan will be important as trying to “react” could prove very challenging.
There are two report days to watch in the month of June. The June WASDE report will be out on Friday, June 10th. The Stocks and Acreage reports will be out on Thursday, June 30th. The WASDE report will be important because the market will want to know what the USDA sees for South America. However the major market mover will be the June 30th report when we get a much better handle on old crop stocks and new crop acres in the US.
In our last report, we talked about the potential to see record acres shift to soybeans from the March report. The corn-bean ratio reached an all time high for this time of year. Some producers were even facing negative margins for corn while having positive margins for soybeans, which was a very clear incentive for those who were able to make the switch. Now that planting is wrapping up without issue, it looks like weather isn’t going to play a major role in the acreage decision this year. With corn and soybean prices both near 2-year highs, we expect combined acres to increase from the March Intentions report. The majority of those acres will go to soybeans in our opinion and some acres will have switched from corn and other crops into soybeans as well. We are going to use an increase of 2.5 million acres for soybeans and a decrease of 1 million acres for corn from the March report. This was one of the largest incentives in history to switch acres from corn, wheat and cotton into soybeans. We have seen switches of 3-4 million acres in the past so we should be open-minded to the potential of a large acreage surprise on this report.
Please give us a call if you have questions about our marketing plan.. Now is an especially important time to make sure a solid plan exists and to ensure nothing is overlooked.
May 9, 2016
April Net Changes:
November Soybeans 83 cents higher
December Corn 26 ½ cents higher
July Wheat 7 ¾ cents higher
April grain prices were quite volatile especially considering the previous seven months of relatively stable markets. There have been record commodity inflows during this time, mostly coming from the Chinese and spec longs. Record daily volume and open interest has been recorded in the soybean contracts. Heavy rainfall in Argentina has delayed their harvest and was an additional catalyst to force shorts to cover and further perpetuate the rally.
The problems in Argentina are only part of the story however. A lot of the spec buying was also fueled by the weakness in the US Dollar. The following chart shows just how correlated soybeans have been to the Dollar over time.
The weakness in the currency has driven the funds to build a large net long position. They started liquidating their shorts in early March, and became net long by March 15th. On the latest report, they have built a long position of 149,079 contracts which is just shy of 750 million bushels! The largest net long soybean position they have ever held was 240,937 contracts back in May of 2012. The graphic below shows the fund’s net holdings of soybean contracts with an inverse US Dollar chart. It simply confirms that the funds add long soybean positions during periods of dollar weakness and sell short during periods of dollar strength.
Soybeans aren’t the only commodity benefiting from the lower dollar. Silver is experiencing an equally impressive rally. The following chart may give some perspective for those who say this strength is exclusively related to the problems in Argentina. To us this is a major confirmation that this rally is mostly related to money flow into commodities rather than a major shift in market fundamentals. In April, the silver/bean correlation was nearly perfect.
Now that the funds have invested, we don’t see this changing anytime soon, nor do we see soybeans heading back to $8.50 until we know more about the U.S. crop size. The global oilseed market is perceived to have a supply problem with the potential for a tightening global balance sheet. Although the estimates are following the price action and are likely overdone, this is the reality of the situation… it’s bullish until proven wrong.
Open interest is record large and we are just now heading into the growing season. Volatility should be here to stay. We need to have orders in and working at your price levels as the market moves are only going to get faster and larger. There is a lot of spec money sloshing around and this can create opportunities…as hedgers we want to take advantage of opportunities if and when they present themselves. In this monthly update we will focus on what we know today and how we can prepare for potential summer volatility.
Although corn has benefited from the commodity inflows its strength has lagged the pace that soybeans have set. The huge 300K + fund buying was quickly met by the record amount of farmer selling that was needed to unload record large inventories remaining from last harvest. A rising tide lifts all ships but when the tide goes out you see who isn’t wearing any shorts. The commodity rally has forced most of the shorts out, even in the corn market. Fundamentally the U.S. and global coarse grains do not have a bullish story without a decent weather problem this summer. Supplies of corn and wheat are expected to increase which is probably why they were held back on this latest commodity advance.
The soybean rally has been nice to watch and certainly has provided some relief, but it is a corn rally that is truly needed most by US agriculture. With corn prices only 15 cents off of contract lows and nearly 50 cents below breakeven for many producers the market could have a long hard year ahead.
Planting weather is off to a great start in most areas… especially for corn. With a near-record pace and good subsoil moisture the setup is there for another record crop. This potential will be thrust back into the spotlight on tomorrow’s WASDE report which is the first to include 2016-2017 estimates.
For this report, the average analyst is expecting corn carryout to be 2.256 billion next year, with a range between 1.764 and 2.557. We have included our own supply and demand estimates in the table below (note: we are using 1.6 million less corn acres than the USDA will be)
Our new crop estimates place carryout closer to 2.385 billion bushels! This is actually a conservative projection considering the 1.6 million acres we are taking away from corn and factoring in a record demand of 13.750 billion. The yield estimate of 168 is actually taken directly from the USDA’s February Ag Outlook Forum. The 30 year trendline yield may be a few bushels behind this, however even a 164.5 yield would still project carryout north of 2.2 billion.
Although we have factored in record demand, we know that will be difficult to achieve. To see another 200 to 300 million US bushels consumed next year may have to come at the expense of either a price drop, US currency devaluation, and/or a supply problem from a competitor. Otherwise, we see Argentina and Brazil coming in with even heavier competition as the US is no longer the world’s low cost corn producer. Some of the recent Chinese policy changes are also likely to have a negative impact on our forward demand.
Given the ultra-large carryout projections, we want to focus on locking in a higher revenue floor as those opportunities arise. Nobody can predict what this summer will bring for weather, but the more confident producers get with their crop size, the more aggressive we would recommend pricing that grain.
Soybeans have been leading the charge higher since our last letter and obviously a few things have changed during this time. It is becoming more and more obvious that a portion of the market was caught short on this rally which propelled it at an even faster pace. This was evident in the volume, opening/closing bell market action, and in the oil/meal spreads. Meal was the contract to be short for a long time which means it was likely oversubscribed, causing one of the most abrupt short covering rallies (in percentage terms) in the history of that spread.
The monthly soybean chart suggests that even more volatility may be on the way. Since 2014, soybeans have had a fairly narrow trading range, especially in the second half of 2015. Prices have tested both the support and resistance of the wedge which means a breakout above the highs could lead to another market run especially if weather doesn’t cooperate.
We have been fairly aggressive in our marketing approach because beans have been the commodity providing the best margin for the most amount of growers. But even though we have had an aggressive number of sales in place, we have been strategic about keeping the opportunities open to raise that floor. By hedging and bullspreading using the May 17 contract we have been able to add 33.5 cents to the original sale price. We have also incorporated the $11 call options on every bushel which is a great way to stay hedged while still having the ability to sell more.
The USDA will release its Monthly WASDE report tomorrow morning at 11:00am. The soybean market response may be volatile simply because of the wide range of carryout estimates. The low estimate is FC Stone at only 248 million bushels! The high estimate is CHS hedging at 748 million and the average is 412 million. Our own estimate is on the high side given the fact we are projecting beans to pick up 1.5 million acres from the March 31st estimates. Even if this acreage change happens it will not be in the WASDE reports until July which is important to note the difference.
We have switched 1.6 million acres out of corn and added 1.5 million to soybeans, however we are being conservative in these estimates. We could easily write-in the case for a dramatic acreage swap this year given the circumstances.
The reason that most analysts are citing an acreage swap is the same as ours, the high corn-bean ratio. By dividing November beans by December corn, we can compare the valuation difference and view it over time. The following chart shows the current 2016 ratio compared to the 10 year average:
The value of November 16 soybeans is currently 2.7 times the value of December 16 corn. Not only is this substantially above the average, it is the highest level for early May during this 10 year period.
High price-ratio’s provide the financial incentive to shift acres from corn back to soybeans, if that incentive happens early enough. The difference this year is the low corn price which is well below breakeven for so many growers. In fact, there have only been 13 trading days in the entire life of the December 16 contract that finished lower than the current price.
Many producers cannot turn a profit in corn at current cash prices while they may be able to with soybeans. In contrast to other years, producers have a more obvious decision in our opinion. When both crops are profitable, it may be hard to judge which one to choose, especially if it means taking them out of rotation. But when planting soybeans could mean the difference of becoming profitable or staying at a loss, the decision may be easier and more likely.
We don’t know if these special circumstances will result in a larger impact than anticipated and won’t until June 31st. What is known is that there are 34 million acres of corn left to plant as of Sunday evening. The market is trying to direct any of those acres on the fence over to soybeans. This is why the spread is hitting the highs now. Even if 10% of those remaining acres switch to soybeans, that would be 3.4 million more. If mother nature steps in for some of these areas that are already behind the switch may happen regardless. We are beginning to believe the swap will be larger -than the market is expecting and will have further write-ups on the matter as planting wraps up.
Wheat ratings have been steadily improving and were last reported at 62% good-to-excellent. The world supply glut is even worse for wheat than it is corn and soybeans, which is probably why it had the weakest gains in April, lagging even the corn market. The funds have reduced some of their wheat shorts due to the falling currency. However, a large portion of those funds appear to be stuck on that position, and for good reason. World wheat stocks have been growing for the last 4 years and this will be the highest carryout in 15 years, back to when wheat prices were at $2.75 a bushel!
We have not changed our demand outlook for wheat since our last report. Our US carryout estimates are 966 for old crop and 925 for new. We continue to advocate hedging on any general commodity strength that pulls July KC wheat up toward $5 again.
To summarize, we see the recent strength as a great opportunity to lock in a higher revenue floor. The supply gluts haven’t gone away overnight despite the price action. The funds have spoken with massive position changes but that doesn’t mean they have to be right. Last summer they did the same thing and the rally lasted for about 14 trading days at it’s peak before it was over and new contract lows were made.
While we can’t predict the weather this summer, we can position ourselves accordingly to protect revenue, and that is a whole lot easier after moves like we just had in soybeans. To be clear, we do not see an increased chance for a national yield problem because of a looming La Nina. The data available is not large enough to suggest that, so we want to remain grounded with our expectations for this summer. The chance to see low yields with high prices is on the table just as it always is, which is why we incorporated the call options and bull spreads. But the real reason for the calls is to provide the confidence to get well sold, which is what we are doing for soybeans.
April 11, 2016
March was an interesting month for grains and oilseeds, culminated by the March 31st report. In this monthly update we are going to discuss some of the problems that have led to the current global supply gluts. It is our belief that markets will continue to have a difficult time holding support over the course of this year unless we see a sudden supply shock such as a drought. World supply continues to expand at a time that it should be contracting. For these reasons, we continue to advocate a sold out old-crop position, just as we have been since October. For new crop, this letter will touch on the corn-soybean ratio, Planting Intentions Report, and the demand impact that South America and China may have on US grains this year.
POST PLANTING INTENTIONS REPORT
The March 31st Planting Intentions release rocked the market with many more corn and soybean acres than anticipated. At a combined 175.84 million, this represents the largest combined corn and soybean acreage in history. From our point of view this is negative for both crops as there are more acres available than are needed for either.
This survey based report had corn at 93.601 million, 2.6 million above the highest estimate and 5.6 million above last year. The initial corn market reaction was clearly negative as it priced in the chance to see a 2.5 + billion bushel carryout or more in 2016-2017. Soybean acres were reported at 82.236 million, down about 800,000 from the average analyst estimate.
These acres are a problem for row crop growers because the market needs to reduce production for these crops, not expand it. Initially, the market’s focus over the next few months is to cut corn acres; 93.6 million is too much for the market to handle without prices suffering.
At this point the corn-bean price ratio has rallied to a level that should entice some corn acres to swap back to soybeans. We estimate corn will drop 1.6 million and beans will pick up 1.5 million. We have included these estimates in our forward Supply and Demand tables. As you can see, even if some acres switch from corn back into soybeans we are looking at large carryouts both in terms of total bushels and stocks-to-use ratios (about 17% for both).
The latest Quarterly report showed March 1st corn stocks at 7.808 billion bushels. The quarterly disappearance was 32 million less than that of a year ago which implies weaker demand, something we have been projecting since early harvest. The USDA has been slow to reduce their demand estimates and have corn carryout pegged at 1.837 billion bushels. At AgYield we have slightly lower demand estimates due to export sales trends and the quarterly disappearance. For those reasons we are using a slightly higher carryout of 1.912 billion.
Our new crop estimates place carryout closer to 2.385 billion bushels! This is actually a conservative projection considering the 1.6 million acres we are taking away from corn and factoring in a record demand of 13.750 billion. The yield estimate of 168 is actually taken directly from the USDA’s February Ag Outlook Forum. The 30 year trendline yield may be a few bushels behind this, however even a 164.5 yield would still project carryout north of 2.2 billion.
Although we have factored a record demand estimate we know it will be difficult for that to actualize unless the market makes it happen by adjusting prices. To see another 200 to 300 million US bushels consumed next year may have to come at the expense of either a price drop, US currency devaluation, and/or a supply problem from a competitor. Otherwise, we see Argentina and Brazil coming in with even heavier competition as the US is no longer the world’s low cost corn producer. Some of the recent Chinese policy changes are also likely to have a negative impact on our forward demand.
Argentina elected a very pro-ag president, Mauricio Macri, back in October. Immediately after taking office Macri allowed the Argentine Peso to free float on the world market by lifting capital controls. This resulted in the following currency move.
This chart is the one year currency move of the USD/ARS. Basically it’s an illustration of how much better off the Argentine farmer is from a year ago. The currency has collapsed by 64% which means more peso’s per bushel received just as the falling US dollar helped US growers receive more dollars per bushel. In theory, this would make them more competitive as they are more likely to sell than store now that they are receiving fair value for their grain.
Not only has Macri let their currency free-float, he has also eliminated corn and wheat export licenses and tariffs. This has obviously opened the door for more of these acres but it goes beyond that. The economics allow those producers to plant a wider variety of crops and therefore they have better yield potential in the future. We expect these changes to not only produce more corn acres but higher yields as well.
Chinese policy changes have been critical to many commodities. They have been unloading stockpiles of copper, steel, cotton and vegetable oils. And now the government is taking steps to reduce their largest position which is actually in corn. As a country they are expected to carry an estimated 4.3 billion bushels into 16/17. This is the USDA estimate and some believe it may be much, much larger than that. This carryout represents over 51% of their actual use for the year. It also represents a failed government policy. The Chinese have attempted to subsidize their growers with a government purchase program that was often valued above the international corn price. By doing this they have attracted a large increase in corn equivalent imports into the country. Now they have a major problem because they have to reduce their holdings during a supply glut. They timed it perfectly, buying it on historical highs and are now about to liquidate on 10 year lows.
To put the size of the Chinese carryout into context, consider the goal of getting down to a stocks to use ratio of 10%. That would be equivalent to taking out 20 million acres of US corn production, acres that would head to other row crops. That is exactly what China is planning for the next 4 to 5 years. They recently announced some acreage swap goals, aiming to reduce corn acres by 8.2 million by the year 2020. The acres would swap to soybeans and potatoes. Soybeans are likely to pick-up most of that lost acreage. This isn’t the best news for the US grower. Less soybean demand from China could eventually lead to higher US carryouts, pushing both crop prices lower in the process. Especially when South America just ramped up production and is going to be competing heavily for that demand.
The bottom line is we believe the recent Chinese policy changes are a bigger bearish factor in the medium to long term than is currently being discussed in the general marketplace.
OLD CROP EXPORT SALES
Weekly export sales have been better over the last few months however they need to remain elevated to catch up to the USDA’s forecast. By this time of year, the US has typically sold about 87% of what it will actually ship for the marketing year. This year, the US has sold 78%. This 9% difference represents a lag of 150 million bushels under the USDA WASDE estimates. Nine percent is still better than six weeks ago when it was 16%, which implies that sales have been stronger and are attempting to close the gap.
Sales typically start to slow down by June as the marketing year comes to an end and South America takes over a lot of that business. To catch up to the USDA pace by then, sales will have to average about 914,000 MT per week. This is certainly possible since the 4 week average is 941,500. However, if sales taper off to their normal spring/summer pace, carryout will grow 150 million bushels and settle near 2.00 billion bushels. Our assumption is that they will lose 50 of that 150 million in projected demand.
Like corn, soybeans will have an uphill battle in 2016, especially if Chinese soy demand remains flat. The world is carrying a record amount of soybeans with no signs of production slowing down. If if the March 31st bean acreage estimate actualized that would be enough acres to grow carryout in 2016.
We believe crush demand is slightly lower than the USDA is writing down. By lowering crush our 2015/16 carryout would jump to 490 million bushels. AgYield’s 2016 carryout estimate is even larger at 640 million, and that is even after factoring a demand increase of 111 million!
The US is not the world’s low cost soy producer. This was evident in 2015/16 as our exports dropped off 153 million bushels from 2014/15. Why did this happen, was demand poor? Actually total soybean use spiked 5.4% as China loaded up on cheap beans. The US didn’t reap the benefit of that excess use for two reasons, the strong US Dollar and large basis discount from Brazil. Had the USD/BRAZILIAN REAL currency pair been weaker during this time, maybe the US would’ve picked up more of that market share.
This Chinese corn stocks problem is just as big for beans as it is for corn. Through support prices, the Chinese government has kept their domestic corn prices very high versus imported soybean prices and consequently soybean meal prices. Because of this, their feed ratio has been running very “hot” for years, meaning their feed rations are much higher in soybean meal than corn compared to the rest of the world. Naturally, this feed ratio should change as their domestic prices realign with world prices for corn and soybeans.
Chinese demand doesn’t have to shrink year-over-year for prices to decline. We believe even an unchanged demand would be negative. Yields continue to grow and more and more ground has been allocated to beans around the world.
Corn and soybeans have built large supply gluts, however wheat is even worse. The following chart shows global stocks-to-use ratios for the 3 main row crops.
World wheat stocks have been growing for 4 years and ending stocks are projected to be over 4 months of demand! This is the highest wheat stocks-use level since 2001, and back then wheat prices were trading $2.75 a bushel!
The market is doing its job to reduce wheat acres in the US but that is part of the reason corn and bean ground is projected to be a record this year. All-wheat acres in the US are expected to be down 9% in 2016 at 49.6 million. This should help the US reduce some of its own wheat carryout burden which is approaching one billion bushels.
Given the supply burden in the US and around the world, wheat isn’t likely to enter a bull market anytime soon. This is why the funds have been so comfortable holding short positions that represent almost 1/5th of the total open interest. The cost of carry is also historically very high for wheat, which means they have tremendous staying power if they want to remain short for an extended period of time.
To summarize, world production is still pointing to growing stocks not declining. More and more countries are trying to compete with the US and the supply glut doesn’t appear to be going away anytime soon. As the market looks for signs of bottoming, it needs to see global production growth begin to slow down, and by all accounts we see the opposite. Growth appears to be accelerating. Without a sudden and dramatic supply shock this bearish trend will be difficult to change.
With a strong Dollar, the US is feeling the full force of this extra supply through reduced export demand. However the US also has the best government support program for growers. This is likely why acres are being added when they so desperately need to be taken out for profitability to come back to a sustainable path.
To see true bull markets form in this global supply situation, we believe the national average yields need to drop by +13 bushels for corn, +3.5 for soybeans, and +7.5 for wheat. This is what it would take to get US stocks-use below 10%. This is certainly possible as we have seen in recent years, however it is not probable. There is still plenty of downside risk despite what many in the industry believe. Our new crop positions are a way to be hedged until crop insurance is likely to take over, while also keeping the upside open in case weather hits this spring/summer. For more information about our marketing approach, please give us a call at 855-266-6241
Febuary 1, 2016
January was a positive month for corn and soybeans after three straight months of decline. The strength came after the January 12th report which showed slightly less stocks held than anticipated. The investment community may have been caught a little short going into this period as well which helped grains rally into the end of the month.
In this monthly update we will focus on the upcoming acreage battle. We will also take a closer look at demand trends, especially the weak corn sales. Our opinion is that poor demand could still weigh on the markets for the next few WASDE reports.
2016 Acreage: The January 12th report was somewhat of a bombshell for winter wheat. The USDA reported all-winter wheat acres at 36.6 million which was well below the average market guess and down nearly 3 million from 2015. After the vomitoxin problems, low prices, and extreme carryouts, this reduction is understandable. But it still begs the question… where do those extra acres go this spring?
Acreage breakdown for the last 3 years:
Without knowing the prices of the next 2-3 months, we believe soybean acres stand to gain the most ground this year. If corn were to gain 25-30 cents in the next month that might change the outcome, however with what we know right now it looks like beans stand to pick up a good amount of acres.
WHY? For starters, soybeans are the obvious choice in a cost cutting environment, which we are certainly in. Plus, many producers have just come off of knock-out bean yields in 2015 and are feeling a little more comfortable designating a larger portion of their acreage to the complex. It also comes down to lending standards. Some margins are so tight that lines of credit have actually restricted some acres from going all corn, due to the maximum loan value per acre. Ultimately, these macro shifts all point to more bean acres in 2016.
Where are these acres coming from? Well winter wheat just lost 3 million acres and we think spring wheat will lose another million as well. Assuming that the US has a normal planting season, another 2-4 million acres WON’T go to preventive plant this year. Cotton could gain up to a million acres, but we think those will be mostly swapped out of corn in those regions. Whats leftover for large row-crop acres will likely go to beans. In that case we could see up to 4 million more bean acres in 2016!
It’s not that beans NEED the acres, in fact it’s quite the contrary. What US growers really need is LESS North American acres in order for prices to stabilize. How does that happen? The infrastructure and debt are already there, it will just take more time for a significant amount of acres to get worked back into CRP. With a record amount of South American beans for sale and an overly-abundant US carryout, the prospects of a soybean rally are starting to dwindle. If we get 85.0+ million bean acres have another favorable yield, US carryout is likely to grow again. There is always a chance for drought in August to put us back into a bull market. We aren’t ruling anything out, however in the mean time the status-quo is negative.
But China is buying a record amount of beans, that should help right?
China has proved to be a price buyer this year, booking a record amount of beans as prices collapsed. Still, their record appetite isn’t causing a supply disruption, the world is meeting their demand needs. This can be seen in the following chart which shows not only a growing world carryout, but a stable stocks-use ratio near the record high:
China’s demand won’t likely bail the bean market out this year, unless a production cut happens in the US. That just puts extra pressure to meet those yields. The only thing we can say is that when a weather event does finally occur the Chinese factor will make it extra volatile.
2016 Corn Acres: Even though the combined corn-bean acreage pie is expected to grow, corn acres are expected to remain flat. If some acres will be lost to cotton, some of the would be prevent-plant and lost wheat acres could go to corn to make up the difference.
The 2016 corn-bean ratio fell to 2.11 on September 11th but has been increasing ever since. A high ratio entices bean acres, a low ratio entices corn acres. Fundamentally the world outlook has changed since the ratio bottomed in September. The 2015 US corn production is much higher than what was anticipated at the time. Also, the Argentine general elections were held in October and November. When Mauricio Macri won, the market started to price in the pro-ag policies in Argentina that will lead to renewed export competition.
2015/2016 Corn Demand
Part of corn’s problem comes down to the lack of demand for exports. We have been saying this for months. Export sales do not match the USDA export estimate and as such they need to lower their expectations on the WASDE reports. In their typical fashion the USDA has been slow to react when it comes to demand trends. Over the last three reports they have lowered their export demand by 150 million bushels, 50 million at a time. This is why the January 12th report had final carryout above the average guess even though quarterly stocks were below estimates. Even after these adjustments the current commitments are about 310 million bushels short of what’s needed to pace with the current USDA projection. With the sales window closing and Argentina still undercutting the US, we don’t see that export revival happening. Therefore, the USDA will likely have to keep cutting the demand by 50 million bushels at a time for the next 4 months at least. The growing WASDE carryouts could negatively impact the market as everyone starts to concede that the US will have a 2.0+ billion bushel carryout this year.
And that chart could result in this Supply and Demand table:
2015/2016 Soybean Demand
Last week the market was shocked to learn about the cancellation of 395,000 MT of soybeans that had been going to China. This cancellation didn’t make a whole lot of sense since it is still not certain that Brazil will be able to fulfill some of its early bookings with China in a timely manner. Even before this cancellation, the sales pace has been behind the USDA by about 97 million bushels. This may not seem like a lot compared to the corn sales deficit, however it would raise carryout by over 22% if those bushels stayed in the US. There are also over 2.4 million MT of soybean sales outstanding to China that are also susceptible to cancellations like we saw last week.
Crush margins have rallied some since our last report but still remain depressed compared to their 50 and 100 day moving averages. It is unlikely for crush to hold a record pace and for that reason we have our estimate down 50 million from the USDA.
March Board Crush Margins:
To conclude we do not believe the market setup has improved since our last monthly report. The January rally should be viewed as a selling opportunity for those that need to catchup on old crop sales. We recommend staying with our current recommendations which are located in that section below. If you have any questions please give us a call or email firstname.lastname@example.org
January 5, 2016
December was a weak month for grains, a culmination of the year apparently. From December 31st 2014 through December 31st 2015, March corn was down 70 ½ cents. There were only 13 trading days from late June through early July when corn could be sold higher than it was at the beginning of the year.
That amounts to a 16.42% loss annually for the forward contract. Interestingly, many commodities should expect to see that kind of carry lost even in a sideways market this year. The current spread from March 16 corn to March 17 for example is 9%. The current cost of carry for crude oil is over 21%! This is a major problem for the investment community that has become an even larger portion of price discovery recently.
Investment money, primarily index funds, hedge funds, ETFs, and large speculative traders, has an uphill battle with carry. Carry is defined as the premium the future month contracts hold over the front month, due to the cost of storage and interest rates. As the front month comes off the board, the next lead month tends to ‘lose’ that premium if prices are stagnant and sideways. Think of it as a negative dividend for those holding long positions.
Over the last several years, funds have poured into long commodity investments to keep a portion of the portfolio in an inflation hedge. Commodities were viewed as scarce at the time, and the ideas of peak crude oil, endless wars in the Middle East, cheap monetary policy, and a rising global population all added to the fear and conviction of the trade. There was actually a backward market for many of these products as supplies dwindled, meaning the long position holder was able to roll and collect money. This probably helped the position stay in place for longer than it should have. However the market has changed.
The world has risen to the demand needs and stock piles have been rebuilt. Not only in grains but in almost every commodity sector around the globe. A few years of great production has resulted in a complete reversal of those bull market years. This is where the funds come in. All of these long-only products that were so popular have taken time to unwind. And in a carry market, the longer they go without a rally, the more they lose in carrying costs.
In addition to this, a key grain chart has just broken through an important target. The combined price of corn, soybeans, and wheat just broke through the support level that has been held for years.
There is still plenty of investment money that could come out of the market which is one of the many concerns we have for price risk in grains. To get back down to January 09 holdings index funds would have to dump over 125,000 contracts.
Commodity Index Funds Holdings of Corn, Soybeans, and Wheat
Last month we talked about why corn was pressing the contract lows and we will continue to focus on those same unanswered problems in the market. The US market share of exports continues to decline, farmers hold a record amount of unsold bushels in the bin, and an upcoming Argentine crop is currently offered cheaper than US corn.
What’s different today is that more time has passed which means the sales window is that much smaller to see a rebound. Also, the South American growing season is well underway and weather has not been enough of a problem to warrant a yield reduction. As time goes on, and their crop is realized, even more premium could come out of the market. Traditionally, US markets look for a rally to encourage acres heading into spring, but a rally from what level?
Exports: We have discussed the slow sales pace that continues to raise the US carryout expectations. The USDA acknowledged this in their December WASDE report by reducing corn exports by another 50 million bushels. We believe they have to ultimately reduce that by 250 million which would bring us to a final 2015 corn carryout of 2.035 billion bushels.
To support why exports could be down 250 million bushels (or more):
What is possible for the price of corn? The two year front month low is $3.18 ¼, we still think that is a potential risk for old crop corn if panic selling ensues. A lot of inputs and debt need to be paid for in the next few months, and that sell pressure is not likely to be met with large end user buying if they have already booked up their flat price needs on the board. The market is capable of lower prices despite those analysts that continue to call for a bottom (many have been since October 2nd). There is still a potential for a weather event in South America this year but those chances are slowly eroding.
2015 CORN POSITIONS
Our old crop positions stand at 100% sold at an average futures price of $4.23. We aren’t recommending a re-ownership strategy at this time but have done some call options for those who are looking for the upside potential. Bean calls have a nice volatility advantage over corn right now which means we can get a larger position on for a lower price but are subject to the bean/corn ratio risk. Since long option risk is defined, we aren’t too worried about the cross hedge and find the benefits to outweigh the risks in many cases. Please call your broker if you want more details on this.
2016 CORN POSITIONS
The new crop position stands at 30% sold using the May 17 futures at an average price of $4.32 ¼, short 50% of production in December $3.50 puts, long 50% in December $4.50 calls for a net price of 12 cents paid (was 10 cents but add 2 cents from $6 call exit – see below).
Update since last month’s letter:
Bought $3.70 Short-Dated New-Crop Corn puts on 85% of production for 2 1/2 cents. (This was to protect the crop insurance revenue guarantee.)
Bought $6.00 December Corn calls for 2 cents (an exit order to once again keep upside open)
Last month we talked about the upcoming Argentine Peso devaluation and its impact on their soybean sales. By that time, it was becoming clear that the new President, Mauricio Macri, would lift capital controls and allow their currency to free float. This resulted in the ARGY falling from 9.77 pesos per dollar to the current price of 13.72. To Argentine farmers, that would equate to a 40% increase in the price of soybeans virtually overnight, on top of a 5% export tax reduction at the same time. While this has sparked some farmer selling down there, it has been less than expected. Analysts were guessing anywhere from 300-500 million bushels to be sold for export, and so far it has only been about 100 million.
Even though Argentine sales have been slow, CBOT futures continue to gravitate toward the contract lows. This has a lot to do with favorable growing conditions in Brazil (generally favorable). If Brazil produces a 100+ million MT soy crop this year, prices could really surprise us to the downside. The demand for US soybeans has been slower than anticipated so far which is also building our domestic stocks.
Soy sales are running behind the pace needed to reach the USDA estimate. For that reason we have lowered our final export demand estimate to 1.625 million bushels, which is 90 million less than the current USDA estimate. The sales window is much shorter for beans than it is corn because of the size of Brazil’s production. Over the last 5 years, the US has sold on average 87% of its final export demand by December 29th. This year, the US has sold 80% which is 109 million bushels short of where it should be to meet the USDA estimate. However much these sales fall short is just going to get tacked on to the final carryout.
Another alarming figure is the sharp decline in crush margins. For a long time this year the market was experiencing very favorable levels which suggested a record crush pace. The USDA was still forecasting a record crush demand on the December WASDE report. Now a different picture is starting to emerge. The last NOPA crush estimate missed by over 5.5 million bushels. Crush margins have tanked and there are reports of Argentine meal imports. Between low margins, fresh imports, and an increased use of US DDGs, we have had to start lowering our own crush demand estimate by 50 million bushels. Without a yield change in January, those two demand reductions raises the carryout by over 100 million bushels from the December estimate.
It is too soon to say that the South American crop is made, but assuming their crop has no more issues we are concerned about the downside. That is why we want to remain with the current hedge recommendations and have sold more beans during the December rally.
2015 SOYBEAN POSITIONS
We should be 100% sold with an average price of $10.03. Like corn, we have not officially recommended to buy calls since we have technically closed out this marketing year. Soy volatility is low right now which means the call options are not a bad price for what they provide. We expect normal volatility to resume through the March 31st planting intentions report.
2016 SOYBEAN POSITIONS
Coming into December we had recommended to be 25% sold at an average price of $9.225 plus another 75% in put protection using March $8.00’s for 5 1/2 cents.
Updates in December:
We have since added another 15% in May 17 futures at $9.29. To keep our upside open, we sold $8.00 November puts and bought $10.00 November calls on 50% of production for an average price of 8.625 cents. And finally, we bought the Nov16-May17 bull spreads at -14 cents on 25% of production, which will also help build upside potential for this low margin environment
In conclusion, we are still very concerned about prices sliding lower because of the record world supply and the poor market setup. We will have more information about the upcoming January reports in next few EHedger evening commentaries. If you have questions about this letter or our current positions, please call us at 866-433-471 or email email@example.com.
December 1, 2015
November net changes:
December corn 17 ¼ cents lower
January soybeans 4 ¾ cents lower
December wheat 62 cents lower
November has passed and new contract lows have been made for corn, soybeans, and wheat. The sell pressure continues to come from the investment community and the managed money has built a decent short position once again. Meanwhile the US grower is still holding the bulk of the ownership. Volatility has remained exceptionally low, which may present some opportunities prior to the January reports. The market will continue to fight the record world supplies while trying to account for weather risk premium in South America. Without a weather event the currency and supply gluts are likely to be heavy burdens for grains.
Our corn market outlook hasn’t changed much in the past 30 days. It has become abundantly clear that the crop was bigger than expected which is why futures hit new contract lows recently rather than making an early harvest bottom like so many analysts had anticipated. The hedge funds appear to be front running the producer, building a large short position with the knowledge that heavy farmer selling is likely to come behind them in the coming months. Judging by the record long-only commercial position in November, it looks like end users have booked a fair share of coverage already. The question remains, who now can step in to bid the market higher, and why would they?
Managed Money Net and Commercial Long Only Positions
South American Competition
The flurry of headlines coming out of Buenos Aires have been mostly positive, bringing hope for many of those citizens who have been suppressed by the socialist agenda of the previous administration. The new President elect, Mauricio Macri, is expected to bring a pro-business agenda and give their agricultural sector a large boost with favorable policies. The problem however is this situation doesn’t bode well for the US producer who now has more competition from a low cost competitor ramping up production. All of the focus thus far has centered on the short term implications; mainly the fact that the market wouldn’t be able to handle the record soybean supply that Argentina currently holds without a large price decline. While this is a concern, the impact of a vibrant Argentine Ag sector will certainly be noticed in the years to come. As you can see from the chart below, Argentina has consistently held the world’s second place title for corn exports, obviously the US takes first. However Argentina has slipped in the last five years and Brazil now holds that market share.
The first thing that Macri is expected to do is lower the corn and wheat export tariffs to zero which will encourage producers to plant what works for them, not what public policy dictates. Argentine corn hectares should be up substantially next year as a result, especially with so many years of planting beans-on-beans. The US is already having trouble competing for market share this year due to the currency disadvantage. Emerging market currencies like the Brazilian Real and Ukrainian Hryvnia have been historically weak which has helped facilitate exports.
The bottom line is that Argentina’s currency is about to go through a major devaluation while their supply gets a boost and this could make it harder for any rally of substance to occur without a major world supply disruption. That is not to say that a rally can’t happen, but if it did, we would be willing sellers with everything currently known.
The EPA was out with its Renewable fuels requirement on Monday. The increases were actually quite large, about 11% from the actual observed volume in 2014. This could positively impact corn usage in 2016 but estimates are running anywhere from 50 to 125 million bushels, but not enough to get anyone excited.
2015 CORN POSITIONS
Our old crop position stands at 100% sold. We aren’t officially recommending a re-ownership strategy at this time but aren’t ruling it out either. This is especially true for those customers who have expressed extra interest in participating if a price rally occurred however do not want to hold the risk of unsold bushels. The one attractive attribute to a strategy such as long call options is that volatility is historically low (not surprising given the lackluster market action). The CBOE Corn Vol Index actually traded down to an all-time low in November, going back to its inception in 2011. Volatility typically rises throughout the month of December as traders gear up for the uncertainty of the January reports.
CBOE CORN VOLATILITY INDEX
2016 CORN POSITIONS
Due to the ultra-low volatility, we are getting very close to exiting our short December 16′ $6.00 call options for 2 cents. This is part of a larger strategy that can be found in our recommendations section below. The strategy change will ensure that we have our upside completely open and not limited. With a full year left, 2 cents isn’t worth holding that risk any longer. If this order is filled, that would leave us with 30% sold using the May 17′ futures at an average price of $4.32 ¼, 50% short December 16′ $3.50 puts, and 50% long December 16′ $4.50 calls for a net price of 10 cents paid. We have a working order recommendation for 20% more sales using May 17′ futures at $4.45. If everything is filled, we will be protected down to $3.50 (61 cents of hedge protection) and will not be obligated to be short if the market rallies above $4.50 (a risk of 38.75 cents). With so much unknown about the next 12 months we believe this is a great hedge to establish on the first half of production.
Jan soybeans have bounced off their contract lows, especially over the past few days. This recent strength may have something to do with the latest Argentine announcement. Rumors had been floating that Macri would temporarily eliminate the soy export tariff altogether in order to boost central bank reserves. This rumor was mostly squashed on Sunday after it was announced that they would go ahead with only a 5% reduction of the original export tariff. That may have been a slight letdown for the bears and we know that the funds just loaded up on shorts in the last few weeks. If capital controls are removed in Argentina, their currency should have a rather quick devaluation and prompt a decent amount of soybean sales in the process, however it will NOT be in combination with an all out tariff reduction. The market will have a better understanding of the currency impact by late December after Macri takes office on the 10th.
Still facing an uphill battle
There are still a lot of negatives going against soybeans right now. The latest WASDE report increased production dramatically. The idea of big crops/big demand likely caused the USDA to raise their demand forecast along with the increased production. If they hadn’t raised demand on this report, final US soy carryout would have been projected over a half billion bushels! US export sales have shown signs of decline and that export window will begin to close soon. We still see the potential for a carryout above 600 million bushels this year. If everything holds steady and Brazil really grows a 100 million MT crop, the price of soybeans could easily trade sub $8.00 in our opinion. This is the reason we have bought the March $8.00 puts as a cheap form of price insurance for the winter. Like corn, soybean volatility has been hammered, and the index traded below 16% vol recently. If you weren’t able to enter these options at 5 ½ cents previously the market rally is allowing that opportunity again.
CBOE Soybean Volatility Index
2015 SOYBEAN POSITIONS
Like corn, we have recommended to be 100% sold (see recommendations section below for more details). For those customers that have expressed interest in having a stake in a price rally (beyond what the 2016 crop will provide) we don’t mind buying March and May soybean options, especially if they are sub 17% volatility. Nobody can predict the weather and this is a much better strategy than holding unsold bushels as an alternative.
2016 SOYBEAN POSITIONS
We have recommended to be 25% sold using the May 17′ futures with an average price of $9.22 ½ and 75% long the March $8.00 puts for 5 ½ cents. The 2016 corn/soybean ratio has been increasing, so we want to be mindful of that getting back to last year’s levels above 2.50. In that case we may recommend more protection, but for now we are comfortable with these sales.
Nov 16′ Soybeans / December 16′ Corn – Ratio
US DOLLAR INDEX
And lastly we just want to point out the ongoing strength in the USD index. This is the main contributor to the commodity bust. This couldn’t be more obvious than in the following chart which compares the USD next to the Bloomberg Commodity Index:
Historically the USD appreciates prior to a rate hike and then declines immediately after. This is probably the “buy the rumor sell the news” rule at its best. However in today’s debt fueled world it may actually be different this time. Many of the currencies paired against the dollar have governments and corporations who have issued large amounts of dollar denominated bonds. With a currency move like we have had this turns into a vicious circle of debt servicing. They sell their local currency to purchase USD to service debt, fueling an even larger currency move that costs more the next time. This would only get exacerbated if the world’s benchmark rate (FFR) starts to increase since new debt will likely be issued at a higher rate as well.
November 2, 2015
October net changes:
November soybeans 8 ¼ cents lower
December corn 5 ½ cents lower
December wheat 9 ¼ cents higher
October produced relatively low volatility considering the importance of this time of year. Harvest is nearly complete and the US has carved out a larger portion of its export sales window. The December corn range was only 27 ¾ cents; the lowest monthly range since May. The soybean range was 51 ½ cents which compares to the rolling two-year average of $1.15. December wheat held a range of 48 ¼ cents which is the lowest range in over a year. The CME Group just changed the maximum daily price limits for grains.
Our corn market outlook mirrors the trading ranges of the past two months. There isn’t a clear reason for a strong bullish or bearish conviction right now. These ranges are a product of our environment: adequate supply, slow export demand and reluctant farmer selling.
SLOW EXPORT DEMAND
For those who have been following our daily letters, you already know that US corn sales have been running very cold. Every week corn sales fall further behind the pace needed to reach the USDA estimate. As of the latest export sales report, corn sales are roughly 425 million bushels behind. While the sales window is wider for corn that it is soybeans, running that far behind will prove very difficult to “catch up”. Furthermore, the factors that have brought us into this situation are still at large. We believe the USDA will begin to acknowledge this demand weakness in the November 10th WASDE report.
Slow export demand is a product of many variables but the foremost is the strong US Dollar. The dollar has been gaining on emerging market currencies ever since the commodity bust. This includes the Brazilian Real, Argentine Peso, and Ukrainian Hryvnia. These countries have consistently undercut US grain prices and many Asian buyers have turned away from US corn as a result. Even the US has recently imported Brazilian corn. A Bunge owned cargo of 54,000 MTs of corn was shipped into US Southeast… in late October! It’s hard to imagine that Brazilian corn would be cheaper to import than to source domestically at this time of year. The implications for final carryout are not good.
SLOW FARMER SELLING
Freight and barge rates have also been down as a result. Interestingly, this has allowed the river basis to stay rather strong since competition is low. Farmers have remained reluctant sellers and domestic end users are still consistent buyers, which has facilitated a stronger Midwest basis. An elevated basis can sometimes lead to a flat price futures rally, however in today’s market that is an especially difficult prediction to make. Sure it wouldn’t surprise us to see the futures rally because of slow producer selling, but if that ultimately translates to demand rationing we could see a growing carryout as a result. The slow producer selling will not have a long-term bullish market influence in our opinion.
There is also the lender’s perspective to consider. The story that we keep hearing is that a lot of “tough discussions” will be had between farmers and lenders in the coming months. We can probably expect tighter controls going into 2016 for those who are levered. Many areas will get large ARC county payments which will buy farmers some time before having to sell more supply to raise cash. However in late December – early January we could see some grain movement for debt extension and cash flow needs. In our mind, the entire industry is betting on the price of corn going up. Either through the price of land, loans against stored grain, or the elevated prices of fertilizer and other inputs. Crop insurance just expired and this may be the lowest amount of protection for a record amount stored. The industry acts like it has a bad trade on and doesn’t want to get out. The market is really hoping for a South American drought to send prices high enough to justify the large input costs.
Below is our latest corn S&D table next to the USDA estimates. In light of the slow sales pace, we have lowered our own export demand estimates from 1.7 billion bushels down to 1.6 billion (the current USDA estimate is 1.85). Keep in mind that the current pace suggests 1.425 so we are assuming that sales will improve before the window starts to close.
To summarize, corn fundamentals appear to be holding the price in limbo. The record amount of unsold bushels and poor export demand has kept the higher prices in check. There will likely be plenty of bushels for sale if the cash price of corn gets back to $4.00, especially with better than expected yields in many areas. At the same time reluctant farmer selling has kept movement slow at the low end of the range, thus providing support. Our own market opinion hasn’t changed much in the last 30 days and we have made no new corn recommendations during that time.
Our old crop position stands at 100% sold and to have December $4.00 call options against those sales. The main reason for buying the call options was to provide the confidence to stay sold through the major harvest WASDE reports and perhaps take more out of the market if it provided. Prior to the September/October WASDE’s, many analysts were bullish, predicting a national average yield below 160 due to the excessive rains. That looks highly unlikely at this point and so many of those same analysts are still bullish but for new and different reasons including El Nino. The point is not to drag along old crop positions on ‘spec’.
Our new crop recommendations stand at 30% sold with a working order for another 20% above the market. Call option spreads are in place to protect the position and are heavily funded by selling the December $3.50 corn puts. The position provides an immediate floor protecting bushels down to $3.50 (we see this first 65 cents down as the most likely revenue to be at risk) while allowing plenty of upside after the first 35 cent rally. To us this is the best way to get a meaningful amount of downside risk covered while still having the chance to get a better average if the supply fundamentals change between now and the end of next year’s growing season.
Soybeans had an interesting October. Although soybean futures finished lower on the month, export sales have been improving. Our strong currency puts us at a competitive disadvantage of course, however Chinese bean appetite is up again from last year. The reasons for the ongoing weakness still revolve around the record world supply. The Argentine elections are also playing a major role in the ongoing weakness since any change in the the way they report their currency could spur large Argentine exports.
IMPROVING US EXPORT SALES
US Soybean sales are taking steps in the right direction but are not yet where they need to be. The USDA recognized the slow pace in the October WASDE report by lowering their estimate from 1.725 billion down to 1.675. The running total accounts for only 60% of thE final USDA estimate which is still behind the 5-year average 10% from where it is normally at this time of year. If sales trend at the 5 year average “pace”, from now until the end of the marketing year, final export demand would drop to only 1.5 billion (175 million less than the latest USDA estimate). We keeping our own private estimate unchanged at 1.6 billion which splits that difference. The chart below shows the 2015 sales pace converging on the 5-year average, but not quite there yet.
US SUPPLY AND DEMAND
Given the anecdotal yield results across the Midwest, our own national average yield estimate is 49.0 bushels per acre. The USDA is likely to change production on the November 10th WASDE report. This will shed more light on the subject, but so far even the harder hit corn areas have reported more favorable bean yields. If yield grows the market may not be prepared for the increased carryout. This is a good reason to stay with the current recommendation and remain 100% hedged in old crop beans. The best chance for soybeans to rally in our opinion would be a South American weather event which is a roll of the dice.
RECORD WORLD SUPPLY
The world carryout is still projected to be a record this year. The Ending Stocks (left axis) have never been higher. And while total use is up, the comparison ratio of Stocks/Use (right axis) is near an all time record high as well.
ARGENTINE POLITICS PLAY A ROLE
A large portion of that record world supply is being held by Argentine farmers who have experienced a 25-30% inflation rate in recent years and a corrupt government that is under-reporting that inflation. The official exchange rate is currently 9.54 Pesos to 1 USD but the black market rate is actually 15.7 pesos to 1 USD. This is an all time record divergence which is extra important because it is an election year and change is coming. President Cristina Fernandez de Kirchner will soon step down from office and the top two Presidential candidates promise sweeping monetary reform. If steps are taken to repeal the previous policies and a floating exchange rate is established, Argentine farmers will eventually get a fair market price for their beans which will be a financial windfall for them. That could ultimately result in a large portion of their record stocks unloaded into the world market. How soon will the monetary reforms be implemented and what will the result be? Those are still unknown but we can be sure that the market is watching these developments closely for direction. This is a main reason for buying the March soybean puts as price insurance. They are an ultra-cheap form of protection for our 2016 bushels that haven’t been hedged yet and they will carry us to late February when the Federal crop insurance prices are established. Its always a possibility that no change comes out of this new president but the market chatter has been growing.
It is an El Nino year and the predictions are calling for it to be one of the strongest on record. While dry weather patterns have been observed in El Nino years we would point out that nothing about the weather is certain. Forecasters have a hard enough time predicting the 10-14 day outlook let alone a whole growing season. We are aware of the El Nino pattern but that will not prevent us from making diligent marketing decisions regarding our price risk.
To summarize, beans are a dynamic crop with many important variables affecting price right now. The Chinese demand has continued to grow each year which is probably the main reason soybeans aren’t sub $8.00 right now. The next three months may start the trend for 2016 since more will be known about Argentine policy and South American weather. Brazil is expected to grow a 100 million MTs of beans this year, overtaking the US as the largest soy producer in the world. If that happens, we could see more risk premium come out of our prices through the winter as the market tells US growers to plant less beans and more corn in 2016. If South America has a sub-par crop it may be off to the races again. Our new crop recommendations have us 25% sold using the May 2017 futures and long $8.00 March puts for 5 ½ cents on the other 75%. Our upside is culminated in that 75% that is unsold and we will make more sales if the price moves higher.
Monthly Report: October 1, 2015
CORN: September was a relatively quiet month for corn. The December contract range was carved out with a low of $3.60 ½ and a high of $3.95, which was much narrower than that of June, July, and August. The funds weren’t very active and posted modest changes throughout the month, quietly lowering their net long position by less than 10k contracts. On the WASDE report, the USDA scaled back their yield estimate from 168.8 in August, down to 167.5 in September, and the market is anxiously awaiting their October estimate which will be released on Friday, October 9th.
The yield reports have been overall favorable, with a few exceptions of course. Even some of the areas that were hit with too much rain early in the year have staged a tremendous recovery. At this point there really isn’t enough evidence to dispute the current USDA yield estimate of 167.5 and so we are remaining with that for our supply and demand estimates.
The table below includes those estimates next to the latest USDA numbers. Our main difference is that we have not been nearly as optimistic on export demand as the USDA has been. The USDA believes that final corn exports will be 1.850 billion bushels, down only 25 million from 2014. We believe exports will be down to 1.700 billion. Even to achieve our estimate the current sales pace needs to improve. With a strong U.S. dollar and strong competition this will be very difficult. High prices over the past 5-7 years have created strong investments in land and infrastructure, most notably in the Black Sea region and in Brazil. This has helped production increase rapidly in those areas. The has also helped foreign competition continue to gain market share from the U.S. during our traditional “gut slot” of October through January. This is a trend that is likely to continue for the years to come.
The following chart helps show why we believe the USDA is overly optimistic on demand. Year-to-date the USDA has only sold 22% of the total government projection compared to the five year average sales of 41%. If the US maintains this pace we will actually be short about 500 million bushels from the current government estimate! So for us to lower the export demand estimate by 150 million we are assuming a major increase in the pace.
Many analysts have been quick to single out weekly sales numbers being higher than the “average” sales-per-week needed to reach the USDA demand. However, they tend to use the entire marketing year to reach that final estimate. This is simply a lazy way of looking at the data. The sales pace does not remain even throughout the year. A large portion of U.S. sales are booked by January (especially in soybeans). The chart above helps illustrate this required pace to meet the USDA estimate. Between now and January 5th for example, we would need to see corn sales average 1.493 million MTs every week to get back on pace, as opposed to looking at the entire marketing year which would require only 765,000 MTs per week. Every week that we sell less than this amount will make the likelihood of us “catching up” less likely.
To summarize, we still believe a position of heavy sales (100% of expected) with basis locked is a good strategy. Our December $4.00 call options are still going to provide that upside potential however we will likely exit these prior to expiration (the current recommendation is to have orders working to sell half of the calls for 30 cents). December 2015 corn is roughly 70 cents higher today than December 2014 corn was a year ago. This is a big difference, especially considering the fact that supply is projected to be similar to 2014 levels while forward demand is severely lagging. The US Dollar has been a main culprit for this lag and since it is still 11.5% stronger than last year the outlook remains bleak. Perhaps the price stays within that $3.60 – $4.00 range from a lack of producer selling. Carryout is likely to grow if these prices stay firm to our competition and no new demand is enticed. If carryout continues to grow through either strong yields or lackluster demand, we could easily see prices in the lower $3’s by the end of the year.
December 2015 Corn compared to December 2014 Corn:
CROP INSURANCE: Federal crop insurance is starting to establish the fall price and will continue to over the month of October for both corn and soybeans. This means the crop insurance “put” will begin to expire and therefore producers will have to reexamine their risks since that price floor will no longer exist.
SOYBEANS: Soybean prices have fallen to corn prices over the course of September (see chart below). This may be in realization of a larger crop size than originally thought, or perhaps the soy demand picture is even worse than it is for corn.
Corn exports account for only 13.5% of total US corn demand. Soybean exports however, account for 46.3% of total demand. Therefore, export demand fluctuations can have a much larger impact on the price of soybeans which may be why the soy/corn ratio trend has turned lower.
Soybean Export Demand: Even with the larger sales reported in today’s weekly report, it is unlikely in our opinion for bean sales to reach the USDA’s final demand estimate. In order to reach the current USDA estimate of 1.725 billion in exports, we would need to outpace last year’s record sales pace by over 200 million bushels from now until the end of August! This is not impossible but is very unlikely in our opinion without a major fundamental change in South America. Our “window” to sell soybeans aggressively to the world is much smaller in soybeans. The following chart is the 2015 export sales pace compared to the five year average.
Over the last five years, 88% of the final exports had been booked by January 1st. To accomplish this we need to see 1.467 million bushels sold every single week until then.
The following supply and demand table compares our estimates to the USDA’s. We lowered harvested acres by 500,000, but raised yield to 49.0 bushels per acre. The production increase comes after seeing a large number of very favorable yield reports.
With heavy consideration of the strong US Dollar and the availability of South American supply, we believe soybean exports are overstated by at least 125 million bushels and so have used a conservative cut to 1.6 billion. We have left the crush demand unchanged at a record of 1.870 billion bushels however we think the market is going to have to entice that demand with lower prices. December crush margins are already fading, trading over 30 cents off the high. Without a strong crush estimate, the carryout could grow even larger. The market’s job is to make sure that doesn’t happen and finding that demand with lower bean prices may be the final answer.
Board Crush Margins:
The Brazilian Real has continued to collapse. In the chart below you can see the dramatic decline over the past several years. Since brazilian farmers are paid in their local currency but their soybeans are priced in U.S. dollars to the world buyer, they have received near record prices. This continues to encourage additional expansion of full-season corn and soybeans as well as aggressive expansion in their second season “safrina” corn crop. This has also encouraged aggressive selling by both the farmer and the commercials on the world market. This has quickly shifted the market share away from the U.S. and is a major headwind going forward.
Brazlian Real Weekly Chart:
To summarize, we see a lot of the same problems from last month still unaddressed. The demand remains poor and yield reports are confirming that this year isn’t going to be a disaster like many bulls had hoped. Emerging market currencies are still collapsing against the Dollar and making our prices less competitive in the process. A large portion of grain analysts appear to be looking for a harvest low to form since this is the day it bottomed last year. We believe there are too many negative factors that are pulling on grains for that to be a clear call right now and would remain well hedged (see hedge recommendations below). Growers continue to store corn and soybeans and wait for higher prices. Although this strategy has worked in the past, this could prove to be a very dangerous bet. The economics and global fundamentals have changed dramatically in the past 2 years…be careful.
September 1, 2015
Corn: The corn market is very polarized as we head into the month of September. The bulls are still counting on yield losses to support the market with the assumption that the excessive rains experienced in the eastern belt will be enough to drag the national average yield lower. The bears are focusing on demand related issues, most notably the export sales pace. Where do we stand? If you have been following our daily reports you are probably aware that we are focusing our attention on the poor market setup and poor demand.
The market setup: Managed money funds have been underwater for a good majority of 2015 and most recently because of their reluctance to reduce positions from the long side. Many of our fellow market analysts believe that the risk of their liquidation is lower because the NET long position has fallen from a high of 279,665 contracts on July 21st, to the current position of only 73,537 contracts (as of August 25th). While this is true, that NET reduction mostly came from new shorts entering the market, not from liquidation. The long side only liquidated 90,082 contracts during that time and have another 70,197 contracts to go just to get back to their lowest position size in 2015. We believe they will exit these positions before year end if the USDA doesn’t start to give them (and their investors) a reason to stay the course. The worst part of this scenario is that it may come at the worst possible time of year, when harvest pressure would be at its highest. Here is a summary of the long, short, and net positions held by the managed money in corn over the course of 2015:
There has also been a recent reduction of shorts by the commercials. We should be seeing this position build leading into harvest as farmer’s make cash grain sales at the elevator, however this has not been the case. This could also be a sign that the producer has a record amount of unsold grain pre-harvest and even more of a reason to see harvest pressure for cash flow and storage needs.
The poor demand setup: When we say poor demand setup, we are not talking about a reduction in demand for ethanol production, or from the livestock industry. Between those two sources, corn usage should be at an all-time high, up slightly from last year. However that is where the enthusiasm stops. The blend-wall and herd size are limiting the growth from those sectors, and we believe the USDA has already reached a max estimate for these categories. Now it comes to the exports. The USDA is forecasting a carryout of 1.713 billion bushels again next year, but that assumes export demand will remain at last year’s final demand of 1.850 billion bushels. Unfortunately, the forward export sales are running well behind. As of August 20th, the forward sales pace is only 67% of where it was at the same time last year. This is most likely related to the strong US Dollar and available supply from our competitors. The Dollar is 14% stronger than it was on this date in 2014 (that’s huge!) and total foreign corn carryout is about 6% higher as well. The following chart is the export sales pace “marketing-year-to-date” for 2013, 2014, and 2015.
To summarize we still believe a position of heavy sales (100% of expected) and as much basis risk as we can unload is the way to go. Basis was a problem at harvest last year and could be again this year with the USDA projecting the same amount of bushels at harvest. Our downside target would be in the low $3’s with last year’s low of $3.18 ¼ being a significant number. There is still a chance to see the USDA lower their yield estimate from the August WASDE like they did in 2010. For that risk, we like staying with the $4.00 calls on 50% of production. To see the rest of the recommendations and how we got to this point, please check out that section at the bottom of the email.
And just as a reminder to what happened last year at harvest, here is the chart of December 2014 corn:
Soybeans: A lot of the same talking points can be made for soybeans as for corn. Export sales are substantially less than they were at this time last year which is likely hinging on the strong US Dollar and world availability. There is a strong opposition from those who believe the US will experience production loss from late planting and excessive rains. Where do we stand? We think there are more cons than pros when we look at the factors affecting price action.
The first negative for soybeans would be the recent devaluation of the Chinese currency, the Yuan. Their forex system is quite unique in that it falls somewhere between a market based (free floating currency) and a government peg against the US Dollar. There are many who believe the Chinese should just let their currency float and be done with it, and that would likely change the import dynamics even more. To keep it simple, just know that a devaluation of the currency is seen as negative for commodities in general because it reduces their buying power.
Another negative is the export sales pace. The record South American production (and their tremendous portion of the record world carryout) is allowing for more price competition. The Brazilian currency, the Real, is trading at a 12 year low. South American farmers are getting more for their soybeans than they did when prices were at a record in 2008! Like corn, this is translating to less forward sales in the US and potentially a smaller share of that export business. The current US sales pace is running at only 57% of last year’s number, and 60.4% of the pace in 2013. Meanwhile, the USDA is only projecting an export sales decline of 5.5%, which may be optimistic. Even with this conservative demand reduction they are penciling in a 470 million bushel carryout! We think it is safe to say the US has a little wiggle room if the yields don’t come in as expected.
The market setup of soybeans is not as bad as it is for corn since the managed money has been quicker to reduce positions to a net neutral situation. They are however, holding a net long position considering the products. The NET breakdown of their holdings in the complex is: long 775 contracts of soybeans, short 9,007 soyoil, and long 45,128 soymeal. If crush margins start to fall toward historical norms that would reflect poorly for these positions!
While the board crush margin could potentially be a negative factor if the funds decide to liquidate their product holdings, it is also generally seen as supportive for a steady crush demand. Commercials are going to want to run at 100% capacity with crush well north of 100+. That means they will be consistent buyers as long as these margins remain in-tact. Crush demand is still capped by crush capacity however, and last year we likely tested the limits at 1.845 billion bushels. The USDA currently has their crush estimate set at 1.860.
To summarize we see the record world supply and currency problems as an ongoing negative force for beans. The market is already trading at contract lows, but we believe there is still downside risk from here. We have recently rolled down our long $10.40 November puts to the $9.40’s (collecting 92 cents) to allow for more upside potential in case yield variability becomes an issue, which at this point is the only hope for an extended soybean rally in our opinion. Currently we stand with 25% of production in straight sales, 75% of production in long $9.40 puts, and 50% of production in long $10.00 calls.