The genius of Isaac Newton was revealed through the movement of the 2008-09 grain markets. Not only was it proven, once again, that what goes up, must come down, but Newton’s Third Law of Motion also was reinforced: “To every action there is an equal and opposite reaction.”
That’s already enough physics, but Sir Isaac’s notions help explain what has happened in the 2008-09 grain markets and what might happen in the months and years ahead.
It is really about simple economics — when prices go up, demand must come down.
As the corn market rationed use of dwindling 2006 crop supplies, price incentives kicked in to spur a dramatic increase in corn acres planted. A whopping 93.5 million acres were planted to corn in 2007, up an amazing 15.2 million acres from 2006.
It was a classic acreage overshoot by farmers. But despite huge corn plantings, demand increases threatened to drain corn reserves to dangerously tight levels at the end of the 2007-08 marketing year. That sparked a never-before-seen rally in the first half of 2008. The price climb eventually destroyed some demand, rebuilt corn carryover to comfortable levels and removed price incentive to plant corn in 2008. The result was a 7.5-million-acre drop in corn planted acres in 2008.
But the more than 700 million bu. demand destruction caused by the run to all-time price highs resulted in a never-before-seen downside price correction, providing less price incentive to plant corn for 2009. Farmers responded with a one-million acre cut in corn planting intentions.
That’s a simple summary of how corn got to today’s situation. Corn’s fundamentals were the driver of the rally, but the simple summary ignores several issues that contributed to the grain rally and to the eventual downside price correction.
SUPPORTING THE MOVE
Record-high 2006-07 soybean carryover provided incentive to increase corn plantings. The corn market bid for acres and the bean market willingly gave up those acres. That contributed to the 2007 corn acreage overshoot, and provided enough supply to build a huge demand base.
Consecutive years of poor global wheat crops erased the wheat supply available for feed use, drove wheat prices higher and forced foreign livestock producers to turn to alternative feeds, primarily U.S. corn. As a result, U.S. corn exports reached record levels even as prices rallied to all-time highs.
Also, geopolitical tensions, demand, general bullishness for commodities and heightened speculative buying interest all contributed to a rally in crude oil. The all-time highs in crude oil pulled corn prices along on the promise of even greater corn-for-ethanol demand as cheaper-priced ethanol encouraged discretionary blending. As the commodity bull gained momentum, speculative buying spilled from energies and metals into grains.
While this was going on, the U.S. dollar continued its multi-year slide through the first half of 2008. That muted the impact of the grain rally on U.S. grain importers and helped maintain higher-than-expected export demand.
Meanwhile, beans reentered the battle. When corn growers overshot corn plantings, bean producers undershot bean plantings. That resulted in too-tight 2007-08 soybean carryover projections from USDA. So as all factors pointed to unprecedented prices to slow surging corn use, soybeans were forced back into the acreage battle to assure adequate supplies in the 2008-09 marketing year.
A more traditional fundamental hit next when record Midwest flooding in the spring of 2008 threatened corn plantings and yields, forcing the market to further ration 2007 crop supplies, driving prices to the mid-summer 2008 price highs.
It wasn’t one factor, but rather was the convergence of forces from many sources that caused the rally to all-time highs.
FORCING THE REACTION
Record-high global wheat prices encouraged record-high global plantings for the 2008 harvest and ballooned supplies from the previous year by more than 1.8 billion bushels. That replenished the global wheat-feed supply, which started to move to livestock producers in June 2008, just ahead of the grain market price top.
Gasoline consumption in 2007 was about 140 billion gallons; it fell to about 135 billion gallons in 2008. That five billion gallon drop helped drive crude oil and gasoline prices down, removing incentive to produce ethanol. Tight margins at ethanol facilities slowed the growth pace of corn-for-ethanol use, pressuring corn prices. And despite today’s lower fuel prices, consumers carried changed fuel-use habits into a recessionary economy, dampening the future for discretionary ethanol demand (ethanol use above levels mandated by the Renewable Fuels Standard).
Ethanol did increase corn demand in 2007-08, but if rising food cost was all ethanol’s fault, how did the U.S. also export a record amount of corn in the same marketing year? Regardless, the idea of food going into gas tanks instead of hungry mouths turned public opinion against ethanol.
And while the Midwest floods peaked in mid-June, the crop got in and growing conditions were very good through the end of the growing season, erasing yield concerns.
Perhaps the biggest factor — a seven-year bear market in the dollar — reversed, causing the commodity run to end.
It wasn’t one factor. It was the convergence of forces from many sources that caused grains to drop more than 50% from all-time highs in a very short six months.
After the most volatile period the grain markets have ever seen, grain futures struck price lows in December 2008 and conditions turned remarkably benign. As grain prices chopped in a wider-than-normal sideways trading range, grain traders paid more attention to action in equities, crude oil and the U.S. dollar than to supply and demand fundamentals of corn, soybeans and wheat. U.S. corn carryover is projected at a comfortable (but not burdensome) 1.7 billion bushels; soybean carryover is teetering on the edge of “too tight” at 165 million bushels; wheat carryover is projected at a hefty 696 million bushels.
Still, anxiety built in the spring of 2009, keeping price volatility high. A slow start to 2009 corn plantings added anxiety to the corn market; the Argentine drought and “short” bean crop made U.S. soybean carryover appear even tighter; and yield uncertainty following a winter drought and spring freeze in hard red winter wheat country prevented a complete price washout in that market.
Exports will end the marketing year about 30% below year-ago levels. Domestically, ethanol company bankruptcies and changes in ownership will result in shutdowns and restarts, dragging total corn-for-ethanol use below early expectations. Feed and residual use will end the year down about 11% from year-earlier. Carryover will be about 1.7 billion bushels. Old-crop usage expectations have bottomed and may work slightly higher into the end of the market year, drawing carryover down slightly.
Demand will be debated over the next 18 months, but domestic and export demand will recover in the 2009-10 season. Growth in corn-for-ethanol use will be driven by mandated corn-based ethanol use. On the supply side, the March 31, 2009, Prospective Plantings Report from USDA indicated corn plantings this year will fall about one million acres from 2008, to 84.986 million. Record-high input costs get the blame for lower-than-year-ago corn plantings and are why $4-plus December corn futures failed to provide price incentive to plant more corn. A slow start to the planting season in the eastern Corn Belt generated some early yield uncertainty, but after 2008 finished with the second highest national average corn yield, planting delays won’t generate much yield anxiety. And with La Nina fading along the equator in the Pacific Ocean and trends pointing to a developing El Nino, most weather forecasters anticipate a growing season with ample moisture and normal to below-normal temperatures. That would make for low risks to yield potential this year and points to a crop of about 12.4 billion bushels. At that, expected use would outpace new-crop supplies by about 450 million to 500 million bushels, drawing 2009-10 carryover down to about 1.25 billion bushels. With a downtrend in carryover, a move back up to $5 corn futures can’t be ruled out.
Looking further out, tightening 2009-10 carryover and even higher corn use, driven primarily by mandated corn-based ethanol use in the 2010-11 marketing year, will increase corn acreage needs in 2010. Corn should once again bid for acres in spring 2010, but soybeans will likely (once again) willingly hand over acres.
The old-crop soybean outlook is bullish, but that bullishness could be erased by the recession. Still, China continues to buy at an aggressive pace; Brazilian supplies will be cleared quicker than normal. Downside pressure on U.S. carryover will remain through the end of the marketing year, giving upside support to bean prices.
Demand will be debated over the next 18 months, but the best call on total use is generally steady with the 2008-09 marketing year. On the supply side, USDA’s Prospective Plantings Report indicated 2009 bean plantings of 76.024 million, up about 300,000 from 2008. Actual plantings will likely be about one million acres more than indicated at the end of March. With low-yield risk, production will likely climb close to 3.3 billion bushels, easily outpacing expected use to drive 2009-10 carryover to over 350 million bushels. With an uptrend in carryover, bean futures will be looking to increase demand by taking prices down.
Bean carryover will swing from too-tight, to too-heavy in one year. With the momentum change in carryover, the momentum also will change for soybean plantings. Look for lower bean plantings in 2010 to limit overall downside price risk.
Old-crop soft red winter (Chicago wheat) is bulging and demand is poor. That’s the wet blanket over the short time remaining in the 2008-09 marketing year. Hard red winter (Kansas City wheat) and hard red spring (Minneapolis wheat) stocks are tighter, but face tough competition from other exporters. The late-year trend for all wheat futures is steady to lower.
Most of the acreage decline from 2008-09 is the result of lower winter wheat seedings, and actual seedings will likely be just under this estimate from USDA’s Prospective Plantings Report. Soggy conditions in spring wheat country at seeding time will likely force some growers to alternative crops. The national average wheat yield was trimmed last fall when fewer highest-yielding SRW acres were seeded. The winter drought and spring freeze in HRW country likely further trimmed national average wheat yield prospects, driving production down to about 2.1 billion bushels. But, bulging beginning stocks will hold total supplies about steady with year-ago levels.
On the demand side, food use will continue to inch higher, but more corn feedings will drop wheat feed and residual use from year-ago levels. Exports won’t match up with year-ago levels, but will very likely beat the historical average. Total use will barely outpace production, dropping carryover slightly from year-earlier levels.
Wheat supply and demand tend to get stuck in a rut, making it difficult to anticipate any significant year-to-year change. Expect the 2010-11 marketing year supply, use, carryover and prices to be very similar to the 2009-10 marketing year.
The major grain markets look to fluctuate as they jockey for acreage. Corn is short-term negative; longer-term positive and even-longer-term negative. Beans are short-term positive, longer-term negative and even-longer-term neutral. Wheat is short-term negative, longer-term positive and even-longer-term neutral. But those outlooks ignore Newton’s Third Law of Motion: “To every action there is an equal and opposite reaction.” The action is economic recession, commodity deflation and spin-crazy printing presses at the U.S. Treasury.
If Newton’s Third Law can be applied to economics, an equal and opposite reaction to today’s economic conditions would feature higher interest rates and high-flying commodity inflation as the bulging U.S. money supply gains velocity and flows through the economy.
Chip Flory is editor of the Pro Farmer newsletter. Professional Farmers of America (PFA) is an adviser for commodity markets and farm policy. View the newsletter at www.profarmer.com .