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The Situation Report - Michael Kvistad
08/16/10 8:10:16 AM
The Situation Report Markets, Price, and Grain Marketing August 13, 2010 For much of this year the dialogue on the outlook for the grains and oilseed markets has been focused on the expectation of good to excellent new crop production resulting in improvements in global and domestic beginning and ending crop year inventories. All along the storyline of the markets was one that suggested a bullish price rally would need to be ignited and sustained by a new crop production threat in the absence of a demand pull economic environment. In the absence of the demand pull economic environment and a new crop production threat the grains and oilseed markets had been trading in a defensive manner much of the first six months of the calendar year. In late June prices for corn and wheat were at levels that were prompting profitability stress for farmers. Since the first of July 2010 much has changed for the grains and oilseed markets in general. The rally in prices has had a meaningful impact on economic prospects for much of the grains and oilseed agricultural industry. Higher prices have certainly improved the economic opportunity for farmers for the current crop year and have opened the window of opportunity for the 2011 growing season as well. It is likely 2010 will generally be another year of economic success for farmers. The impact of this should not be overlooked as we move forward in the discussion of the 2011 crop year as well, as it may again set the stage for farmers to have the financial means to aggressively respond to the current higher prices with major current production technology investments for the next production cycle. The effects of this investment in production technology has been evident in recent years as corn, soybean, and wheat yields continue to ramp up. Granted the ill effects of the 100 year drought in portions of the FSU are having a negative impact on global wheat production, but the positive impact of production technology investments remain. Beyond the farm the price rally and reasons for the price rally also portend meaningful impact for the industry. Transportation asset utilization will likely improve as the U.S. is called on to transport additional inventories of grains and oilseeds. A case can be made the stage is set for higher transportation costs on a sustained basis than would otherwise be experienced. This consideration may be more linked to rail, barge, and ocean freight cost issues than to local trucking costs for grain shipment. But in a market environment in which interior basis markets are already historically cheap, an increase in US export volume as a result of the recalibrating of the global wheat trade matrix, may work to keep transportation costs high on a prolonged basis. This doesn’t mean the delivered basis markets to the export destination cannot or will not rally, only that the increased freight costs may work to keep interior basis values much cheaper than otherwise. Also impacted by the recent run-up in the grains and oilseed markets are the consumptive users of grains and oilseeds. In recent years lower prices have worked to encourage demand/demand growth. The grains and oilseed industry have not had to deal with “artificial influences” like the auto, health care, insurance, and financial industries. The grains and oilseed industry has had the luxury of having the task of balancing supply and demand linked to the markets and price. We have not had cash for clunkers program or home buyers tax credit issue that diffuses the task of the market and market economics. As a result the demand for global grains and oilseeds has remained at or near record levels as the markets, through price, have sought out and encouraged demand while many other and for grains and oilseed agricultureindustries continue to be plagued by recession and/or deflationary considerations of demand. Thus when concerns about production declines are presented the markets are working from a demand base that truly reflects economic considerations rather than demand that is impacted by an “artificial influence”. But the economics of the market also work when prices rally in a meaningful manner. It is likely the recent price rally will lead to some demand stress in areas of corn processing, wheat processing, feed demand for wheat and corn, etc. issues are realized history suggests they will be very stealthy in their impact. The markets will likely not realize demand stress in a public announcement, but rather over time demand may be deferred and/or limited on a longer term basis. The markets will likely look back over a meaningful period of time and then realize the negative demand effects. Another consideration of the higher prices is the impact they will have on planted acres for the upcoming crop production cycles. A case can be made farmers will not only spend more money on production technology to support the crops’ production, but they will also work aggressively to plant crops in response to the higher prices. $7 plus wheat will likely get the farmers’ attention as the fall planting season approaches for the northern hemisphere. While some may say higher prices for corn and soybeans will counter some of the enthusiasm for wheat acres, I suggest we need to consider the timing of the planting season combined with the potential benefit of assured profits via revenue based crop insurance. U.S. wheat farmers may have an opportunity this fall to lock down very attractive profits on winter wheat if prices hold at current values during the window in time during which the futures component of the revenue assurances of the crop insurance is fixed. These same considerations are not available for spring planted crops until the spring of 2011. Given that as recently as 45 days ago the wheat farmer was concerned with prices that portended profitability stress, it would seem winter wheat farmers will find the ability to engage a marketing strategy (revenue based crop insurance) as a very attractive consideration to support fall planted acres. Another consideration supporting wheat acres is that wheat is a weed. I have heard many a farmer tell me they can grow wheat in the middle of a crack in concrete if they can just get some timely rain. I fully anticipate there will be ample economic incentive in place for farmers to take advantage of the “put” of revenue based crop insurance to support profitability and financial considerations for 2011 for a crop that basically can be grown anywhere, if wheat prices continue to hold at levels that are considered highly attractive for wheat production. This may or may not meaningfully impact other crop acreage issues. However I will note harvested acres for winter wheat can be tweaked higher not only from simply planting more acres, but also from keeping the winter wheat in production rather than grazing. Higher prices for corn and soybeans will also likely work to encourage planted acres for the spring of 2011, but the timing of the potential profitability lock of revenue based crop insurance is not an immediate consideration as it is for the winter wheats. Earlier this week the USDA issued the updated data of the WASDE report. Given the market and price developments of the past 5 weeks this report was anxiously awaited as many anticipated some clarity to the question of what adjustment the USDA would make in response to the hot and dry growing season of the FSU. These reports have taken on additional considerations beyond the actual data of the report over the past number of years. The market and trade no longer simply compare the data versus the previous month’s data and prior year comparison. These issues are ultimately important. But for a period a couple of days prior to and after the issuance of the USDA report, the markets focus a good deal of time massaging the expectations of the report and then the actual report data versus expectations. To a great extent this is broker chatter and for purposes of conversation with clients I prefer to focus on the actual numbers and their relevance to real supply and demand balance If these demand stresssheet issues rather than what someone thought the data would be. If one takes the USDA report at face value the bottom line is that in spite of all the price euphoria of the past 5 weeks, the report suggests the global wheat, corn, and soybean markets will have adequate (corn) to ample (wheat and soybean) inventories to move through the crop year. Yes global wheat production has been negatively impacted by the problems in EU and FSU, but global ending stocks projections remain at more than adequate levels (175MMT). Global ending stocks for soybeans also remain historically high (64MMT). Global ending stocks for corn (139MMT) are somewhat tighter on a relative basis than soybeans or wheat and support the argument that the corn market may need to work to attract corn acres for the spring of 2011. But to this point the disaster projection for global wheat issues that some have feared prior to the report and in the heat of the recent price rally, does not appear to be in hand. Might the USDA make further downward revisions in inventory in coming months for wheat? I think the answer for wheat may be yes but the wheat market is at a very different price point that it was when the July USDA report was issued and the current price rally really began. has done a significant amount of work recalibrating the global export trade matrix, getting the investor/funds long wheat, and encouraging the new crop considerations of 2011 as a counter to the current crop year production decline. market’s adjusting fundamentals as well as changing and impacting the future task of a market. The following is some inside baseball relative to the wheat market. I will warn you in advance some of you may find your eyes glazing over as I go through this consideration, but I find this to be fascinating as well as pertinent. Even with the most recent downward production adjustments made by the USDA, the global beginning crop year wheat inventory will total 838 MMT versus the prior crop year of 845 MMT. These are big numbers from a historical perspective and do not suggest any tightness in 2010/11 crop year global wheat inventories. The ending stocks projection for global wheat inventories is now at 175 MMT versus last year’s stocks of 193 and versus the previous year’s stocks of 165. The global wheat market considered the ending stocks of 165MMT as bearish a couple of years ago. There is a case to be made the current crop year ending stocks projection of 175 MMT is not even close to being a tight ending stocks scenario. But why have the wheat markets rallied as vociferously as they have? There may be a few answers to this question. 1. The global demand for wheat remains historically strong and there has been a bit of a panic for consumptive users to get price coverage until they could better quantify the extent of the production problem in the FSU 2. The investor community that participates in grains and oilseed markets had been waiting and looking for a sign of the next bullish market. A hot and dry weather consideration is exactly what gets these “race horses” out of the starting gate. They were not meaningfully invested/long wheat futures at the end of June but now are. 3. There has been a scramble to re-sort the global trade matrix as production problems in the FSU were unfolding. The trade has had to respond to the potential and reality of contract default on export shipments from the drought stricken area. When this type of event takes place, those who are threatened by non performance on contracts don’t typically wait and hope the problems don’t escalate. They typically get coverage and worry about the details later. In some instances this results in double buying. But through all of this the part that I find most interesting is that the market is still beginning the crop year with an inventory that is historically large. The wheat markets had a carrying charge price structure in place in response to this inventory issue when this price rally began. The system still has The wheat marketPrice and price action are very good at responding to aplenty of wheat and as the wheat markets have rallied, the price rally has to a great extent forced the deferred months and next crop year to rally as well reflecting the current inventory surplus. At the end of the crop year, even with the reduced current projections, there is going to be a very large surplus inventory. The price enthusiasm of the current price rally has to a great extent been reflected in the futures markets rather than the destruction of the carrying charge price structure environment of the wheat markets. I am not sure the destruction of the carrying charge price structure in its totality needs to be accomplished. I warned you that this was going to be a bit of inside baseball and here goes. Any locations price for grains and oilseeds is comprised of the applicable futures market price plus or minus the location’s basis. To a great extent it is believed the futures markets tend to reflect the big picture considerations of the market and the basis markets tend to be the mechanism to address regional and/or timing issues for grain movement. With that as the framework for price the questions then become what is the task of the futures market and what is the task of the basis market given current wheat market considerations? Answers – 1. Once the inventory of the wheat market is better understood and if current inventory general considerations remain intact (historically large beginning inventory) the rally in the wheat futures market may be over. I think the market is reasonably close to determining the inventory issue and it is still historically large. Maybe this issue comes to a better understanding in the next couple of weeks. The current price rally in wheat futures has created a price consideration for wheat that is very attractive for sellers and distressful for buyers. Equally important the attractively high price for sellers of wheat may be enticing a significant majority of the wheat to want to get sold quickly. The market does not need 838 MMT dumped on it to satisfy demand realization in the next couple of months. This is like standing behind a tri-axle sand truck and getting the entire load dumped on you when you only need a yard of sand. It is dangerous and if you do it you will likely get crushed. 2. Then the process begins relative to addressing the realization of demand. This is different than the process of pricing demand. To a great extent demand can be priced by buying the futures market. A case can be made the pricing of demand to a degree, has already been done as the futures markets have rallied. Then the issue of realizing the demand (physicals execution) begins as the demand calendar marches forward. We need to keep in mind much of the demand for global wheat inventories is that of flour and livestock feeding. There are competing commodity inventories available for both to displace wheat usage and there is plenty of wheat still available. The current price rally in the futures market may be encouraging competing flour and feed grain inventories to displace wheat usage. I think it is and as mentioned in item 1, the price rally may be threatening to hasten or dump a very large inventory of wheat onto the market as well. The realization of demand and the sourcing of wheat inventories to satisfy demand on a global scale and domestic scale may then become a task of the basis markets. The basis markets have the ability to sort inventories to satisfy demand and the ability to control the flow of inventory from the wheat dump truck as well. 3. Next the question of how the basis market goes about sourcing the needed wheat to satisfy demand is presented. If the wheat futures markets move lower, the basis markets will begin trying to encourage enough wheat to move to satisfy the demand calendar/timing of demand. If the delivered export basis market location rallies too much this too acts like a futures market rally in that it may encourage too much wheat to move in too tight a time frame. I think the task of the basis markets is to rally in the interior locations first and on an on-going basis (no pun intended) to time the wheat supply delivery and quantity with demand. It is the throttle that can sort at point of origination to get the quantity and quality of wheat needed to address demand realization. I am not bearish interior basis markets for wheat at this time. I want to finish this Report with comments on the corn and soybean markets. First is the issue of the beginning new crop year inventory. For both current data projects historically large global and domestic inventories. The crop year for corn and soybeans will begin the year much as the global wheat markets, highlighted by ample inventory. Demand for the crop year is projected to be historically large reflecting the work of lower prices over the past number of months to support demand. Interior new crop basis levels for corn and soybeans remain historically low. Because interior basis markets for new crop are already historically low and because new crop demand looks to be robust, I do not think there is much room for the new crop basis markets to move meaningfully lower on a sustained basis. As far as the futures markets for corn and soybeans go, it would not surprise me if both experience a pull back in prices. The markets are technically overbought and the funds are meaningfully long. I also anticipate both corn and soybean yields/production will be higher than the USDA has projected in the August WASDE report. This may not be a game changer in terms of the supply and demand balance sheets, but it may help a market pull back futures market prices if the liquidation of the funds and technical price analysis price correction are engaged at the same time the production increases are announced. I know there is chatter in the market about the need for the corn market to “buy” acres for the 2011 northern hemisphere growing season, but there is plenty of time for that the current production cycle suggests that to be a task of the market over the winter months. But what if the current production cycle finds another 2-3 bushels per acre production for the current crop year? Then the task of the corn market to buy corn acres over the winter may be much different than the current spring 2011 planted acreage discussion implies. I am still a believer in the positive impact of current production technology and do not think we know what that means in terms of production for the 2010 production cycle. We generally have had good or better than good weather for much of the U.S. corn and soybean production cycle even if one considers the warmer temperatures of the past couple of weeks. I think the price rally in the corn and soybean markets over the past 5 weeks should not be overlooked as an opportunity to be addressed. In closing I want to mention the following dodge/shake off what looked to be bearish markets earlier in the growing season, this year and last year. Mother Nature intervened in 2009 to cause concern about production and the same can be said this year as concerns about FSU wheat production were realized. concerns prompted a meaningful price rally that to a great extent allowed grains and oilseed production agriculture to experience profitability opportunities that earlier in the growing season looked to be slipping away. I am uncomfortable hoping these production concern pricing opportunities will be present on an on-going basis. They may, but I also believe there is clear evidence production capacity globally for grains and oilseeds has shown the potential since 2007 to grow production at a faster rate than demand growth. The positive impact of production technology and the financial capacity of farmers to engage this production technology has created an environment in which absent adverse weather, global production potential of grains and oilseeds can and has increased meaningfully. I don’t think this should be overlooked as farmers consider the opportunity afforded as a result of the current price rally. Thanks for being a Client! |
