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!