From the June 01, 2008 issue of Futures Magazine • Subscribe!

Don’t go against the grains

As we enter the growing season there is a certain unease among grain traders who are increasingly being held accountable for the rapidly rising cost of food. With historically high acres in production, the world is awash in grain, yet carryout levels are staggeringly low and stories of food riots and rationing fill the evening news, not only in third world countries, but also at West Coast grocery stores. Rapidly rising food costs, or ‘agriflation’ is the new watchword.

“Geopolitical concerns used to be entirely confined to the crude oil market,” says Elaine Kub, analyst for DTN. “That was the sexy thing that tied the world together and it was easy to understand how it was related to the human condition. But now wheat, corn and rice, they are just as sexy as the oil markets, if not more so, because they are critical to how we see the world and to geopolitical stability.”

Demand more

In addition to a much weaker U.S. dollar, which is supporting U.S. exports, around the world there is an enormous and emerging middle class, observes Robert Kurzatkowski, futures specialist at OptionsXpress. “Developing nations’ appetites are changing. China, India, Russia and South Korea are feeding more cattle and hogs for slaughter, and what people don’t realize is that the amount of food required to feed those animals is much greater than the amount of grain they would eat themselves. Their consumption has increased exponentially. And with China potentially getting away from the one child policy, that demand will continue to grow for some time,” he says.

In the face of rising demand and rising prices, many countries, including Russia and Argentina, have become protectionist, curtailing wheat exports and putting more pressure on the U.S. crop to compensate. And after a year in which high protein wheat prices rocketed to $25, wheat production is up. Australia, which had suffered years of serious drought, is on the rebound, though exporting less wheat, and India is reporting a huge increase in its wheat crop. “A lot of countries have gone overboard and given a huge amount of acreage to wheat,” Kurzatkowski says, and unless they are planting new land, that larger wheat crop will come at the expense of corn or bean production.

Increasing globalization of the grain markets reminds grain analyst Victor Lespinasse of the markets in the early 1970s, when the former Soviet Union began buying unprecedented amounts of grain on the world market. “That triggered a huge boom in grain futures trading here at the Chicago Board of Trade and it pushed prices to all-time highs. And then we had weather problems, too. We had drought, we had a Labor Day weekend freeze. We had corn rocketing to $4 per bushel for the first time in history. In ‘73, we had beans get up to $12.90 per bushel after starting near $3 per bushel. Prices exploded,” he says.

One important difference though is that the rallies from the 1970s were short lived. This rally has been ongoing, driven by huge volume, violent volatility and the recent introductions of electronic trading, 23-hour markets, increased position limits and long-only funds that have radically altered the markets.

In the first quarter of 2008, Chicago wheat has endured a wild ride, surging above $13 before falling below $8 at press time. Rick Brock, president of Brock Trading, says the top is in for July Chicago wheat, which will trade between $7 and $9 per bushel.

“The market essentially did its job,” says Jim Bower, president of Bower Trading. He says that all-time high prices in the 2007-2008 growing season encouraged wheat production across the globe and induced the European Union to end its set aside program, and good winter conditions in Europe, the former Soviet Union and Ukraine have helped spur production. “We should have 50 million to 55 million more metric tons of global wheat production than last year,” he says. Barring any weather problems, he is expecting huge production. “Wheat is definitely the weak link in the grain chain right now, and I would be inclined to short December ‘08 wheat on rallies into technical overhead resistance. It would be lower than we are now, if not for the price of corn and soybeans,” he says, adding that through June, he expects wheat to trade between $7.50 and $8.50 per bushel.

“It would take a disaster to turn this trend around,” Kub says, and with nothing in sight to keep them from going lower, she expects front month Chicago wheat to trade between $7.50 and $8 per bushel. Durum wheat is the exception, having traded as high as $25 per bushel in February. That could happen again, she says, despite the fact that the wheat markets have been moving in tandem due to electronic trading and consolidation on CME Globex. “Durum is still in danger of not meeting their supply needs. They don’t have any carryover stocks,” and dry weather in North Dakota and slow planting in Canada have created significant upside potential.

There is no reason at this point to expect anything other than normal weather, Lespinasse says. “If we have normal weather, farmers are going to respond as they always do when they see high prices: they are going to ramp up production,” he says, and wheat will trade down to $7.75 per bushel. “India announced they are going to have a record wheat harvest. Their farm minister said they are not going to be importing any wheat this year. Australia’s weather bureau said they will have above normal rain because of La Nina in May through July. They are predicting a record crop there. They have to plant it first, of course. But right now it looks like a huge crop. The E.U. is looking for a bigger crop, and as a result wheat has broke more than $4 per bushel.” In addition, China’s news agency says that because of heavy rains, they are expecting a bumper wheat crop this year in their two biggest wheat producing regions: Hunan and Shandong.

“We have done a good job of over planting it,” Kurzatkowski says, and as a result prices have slumped. In June, he says wheat will likely trade between $7.80 and $9.50 per bushel. “$10.50 will be a huge sticking point,” he says and end stocks will end up for the year.

Corn dogged

By late April, planters in Iowa, Indiana and Illinois ordinarily would have planted a third of their crop, but persistently cold wet weather has pushed planting back and created increasing uncertainty about acreage, which may be diverted to soybeans unless warm dry weather arrives soon.

“We have seen record highs in corn because of that uncertainty, so you could say that uncertain fundamentals are bullish,” Kub says. “But they are bullish and vulnerable to correction,” which could happen by June. “If you start to see a major lower reaction in corn, that means we planted 86 million acres or more. The futures market itself will respond to that,” she says. Then it all comes down to the weather. By June, corn could be $7 to $10 per bushel, or if we get perfect weather it could trade at $5.50.

Discounting weather issues, Brock says December corn futures will trade between $5 and $6.50 per bushel. “We have had a cold, wet spring and people say that Mother Nature will balance things out by giving us a hot dry summer. Obviously if that happens, it would ignite this market.” However, Brock says that due to advances in corn genetics, the impact of drought would be very small compared to what it was 10 years ago. “Five years ago when drought hit northern Illinois, there were many producers in Dekalb that didn’t have more than half an inch of rain after they planted the crop and ended up with 170 bushels of corn,” (above average) and that nationally, drought has not caused a sharp decline in soybean yields since 1988. “Droughts are like surgery. There’s no such thing as minor surgery if it’s yours. If a drought hits your farm, it’s major. But nationally, it has not had a major impact on yields since 1988,” he says.

Bower says there hasn’t been a below trendline yield since 2002, but the likelihood is increasing. He says 39 times out of 100 we should expect below trendline production; the odds of a trendline yield are about 28%; and above trendline yields occur about 33% of the time. “So there is a high probability of a below trendline yield either this year or next year.” If yields were reduced one or two bushels below trendline, and if the market can’t buy back two million soybean acres, Bower says his supply and demand table points to a dangerously low carryout for the 2008-2009 crop. “With 700 million carryout, isn’t the world going to panic? That’s dangerously low,” he says, and business would become even more difficult for poultry and livestock producers and feed lots.

Another driver has been ethanol production, which Bower refers to as an unfunded, unfounded mandate. “If you keep the fuel mandate at the current levels, which involves an increase of 985 million bushels of corn for ethanol usage, we still come in with a demand aspect that is pretty much the same as last year, even though our crop size this year, if you use the March 31 numbers, draws down production by about 800 million. So when you combine all that and put it in the supply/demand equation, that means we reduced carry out to somewhere around 700 million bushels, which is dangerously tight.”

Lespinasse says traders are working with a new model. “These other factors are not going to go away even if the weather improves; and it’s going to take time to improve the very tight stocks we have.” He says July corn will trade around $5.75. “It will go down from its current level of about $6, but it won’t go much below $4.50.”

Bean juiced

One of the most interesting developments in the soybean markets of late is the premium for old crop beans, Kub says. And that spread has widened to more than $1 between the May and November contracts on the expectation that we will soon have plenty. “That’s an inverted market for grains. Ordinarily you see deferred contracts worth more because of the carrying cost,” Kub says. In June, she says beans will trade between $12.60 and $15 per bushel. Part of the uncertainty is from the farmers strike in Argentina, which again threatens to take South American beans off the market come June 1.

Brock says a long-term top is in for soybeans, and they should trade between $9.50 and $13.50 per bushel and his bias is towards the downside. “Soybeans are a legume and should not be as susceptible to drought like corn is,” he says. “There hasn’t been a dramatic yield drop since 1988.”

Kurzatkowski notes, “We are going to see stabilization in soybean and wheat prices. Soybeans are going to comfortably trade between $11 and $13. Unless things change, $13.50 is where we are going to see stout resistance.” The health of China’s crop also will be a factor, as will the price of cotton, which is an easy substitute for beans, but cotton would have to rally significantly for that to be a factor.

“Forecasted end stocks are only 95 million bushels and that is really low,” Bower says, and usage globally is up about 10 million metric tons per year. “The market wants to see more acreage in place and to see more usage slow down, but it really hasn’t and the demand for protein in China continues to increase. We have to have a good crop in soybeans this year.” The new standard for beans is likely between $9 and $11 per bushel, Lespinasse says, but in June, July beans should be $13.50, and November beans $12.

The reaper

Production is always crucial and in the coming weeks and months, weather will ultimately decide where corn, beans and wheat are trading. These markets will increasingly be driven by international demand, which is huge and growing. In many ways, the grain markets have changed more in the past two years than they had in the past 100 and traders must measure the large speculative interest and energy fundamentals in their analysis of the sector. These factors also have brought more attention to agricultural, environmental and humanitarian issues, chiefly hunger and poverty. “The world is damn well aware of what’s going on now. I have never seen the media and the public so focused on the food price,” Bower says. “I have never seen anything close to this. And that’s good. We need the leadership to understand how this market works.”

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