While the wide swings in energy prices dominated headlines for much of 2006, the grain complex has quietly established its most impressive bull market in a decade. While wheat gained from crop problems in a variety of producing nations, corn prices have spiked primarily because of ethanol production finally ramping up in the United States. With U.S. ethanol production widely expected to increase in 2007, specs and funds alike have continued to buy corn, driving up prices in anticipation of steadily building demand eating away at available supply.
Soybeans have experienced what many feel is a “sympathy rally” with corn. While soybean oil is a component in bio-diesel fuel, ethanol seems to be getting the media attention and new production facilities.
The ethanol story, however, is one with many questions. While it is true that new production facilities are going up quickly, demand for ethanol is unknown, especially with oil prices back near $55 per barrel. While much of the corn buying has been from speculators betting on increased 2007 demand, soybeans have rallied on the theory that higher corn prices will mean U.S. soybean acreage switching over to corn production in 2007. But ethanol or no ethanol, the bottom line supply/demand numbers eventually determine the price of every commodity, and the figures for 2007 soybeans do not paint a bullish picture.
Despite all the corn/acreage/ethanol hype, the United States is facing the highest soybean ending stocks ever. For investors not familiar with soybean supply terms, ending stocks are a measure of supply left over after all usage (demand) is satisfied for the crop year. Crop years for U.S. soybeans run September to September. Therefore, ending stocks, also known as ‘carryout,’ in September 2007 will be the number of soybeans the United States has left over from the 2006 crop when the 2007 harvest begins.
As of the latest USDA estimates, the United States will have 575 million bushels of soybeans left over in September 2007. This is due in large part to the massive 2006 U.S. harvest, which yielded approximately 3.188 billion bushels of soybeans, another record. The United States has produced three consecutive years of bumper crops. As a result of this and heavy production from South American producers, world ending stocks are also expected to hit a record in 2007, pegged to come in at 56.15 million metric tons.
This figure alone makes $7.00 soybeans appear overpriced in our opinion. But speculators who bought soybeans off the ethanol media coverage might be in for another rude awakening next month. For just as the United States is busy trying to unload it’s soybean supplies on the world market, its main competitor, Brazil, is gearing up for it’s own harvest, which begins in March. It is common for world importers to begin switching forward orders to Brazil this time of year, as pre-harvest Brazilian beans will often offer lower prices.
Historically, this price competition has often meant U.S. producers will lower prices to compete – at least temporarily. This has come to be known as the February break in reference to prices. While there is no guarantee that this type of break will occur this year, we see every reason why it should.
Brazil is expected to harvest 54.9 million metric tons of soybeans in 2007. This production would not only eclipse last year’s bumper crop by 5.1%, but would mean a record Brazilian harvest if realized. These figures clearly indicate there is no shortage of soybeans at this time. Bulls will argue, however, that the market is pricing a future shortage, based on U.S. farmers switching acreage intended for soybeans over to corn to meet growing ethanol demand.
Let’s examine this argument.
While the USDA has not yet released its planting intentions report for the 2007 U.S. crop, private estimates have U.S. planted soybean acreage pegged at 70.878 million acres. If realized, this would indeed mean a 6.1% decline from last year’s 75.35 million planted acres. Given the expected sizable 2007 ending stocks and assuming an average 42 bushels per acre yield, this would still result in a roughly 336 million-bushel ending stocks figure for 2008. This would certainly be well below 2007 ending stocks, as the bulls will eagerly point out. But 336 million bushels of beans would still be more than each of the six previous seasons ending with the 04/05 season. In other words, even if soybean acreage is reduced by the amount that private analysts are forecasting, 2008 ending stocks will still be hefty by historical standards.
To summarize, while the ethanol issue is bound to bring a few treasure hunters into the soybean market, longer term fundamentals should serve to keep a lid on any runaway price moves. In the shorter term, we are approaching a time of year when supply and price competition are typically at their apex.
We believe prices will react accordingly, especially in this technically overbought market.
March through August soybean contracts are still delivered against the 2006 crop. We feel selling call premium at strike prices far above today’s market price will offer investors high probability opportunities in the coming weeks.
James Cordier and Michael Gross, Liberty Trading Group
Liberty Trading Group
401 East Jackson Street
Suite 2340
Tampa, FL 33602
(800) 346-1949
www.optionsellers.com
Be sure to catch Liberty Trading’s James Cordier live at the World Money Show, Gaylord Palms Resort, Orlando, Florida, February 7-10th 2007. James will be speaking as part of the Futures Magazine Panel of Experts and will be discussing option writing strategies and his outlook for 2007 commodity prices.
James Cordier is head trader and president of Liberty Trading Group, a futures brokerage firm specializing in option writing on commodities. James’ market comments are published by international financial publications and worldwide news services including The Wall Street Journal, Reuters World News and Bloomberg Television News. Michael Gross is an analyst with Liberty Trading Group. Cordier and Gross’ book, The Complete Guide to Option Selling (McGraw-Hill 2005) is available at bookstores and online retailers now.
***The information in this article has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.
