One of the biggest commodity stories of the year has been the one-way trip much of the grains market has been riding since the end of June. While the initial driving force was the Russian drought and subsequent Russian ban on grain exports for a number of years, other factors such as constricting supply, other global weather problems and production questions helped extend the rallies seen in wheat, corn and soybeans.
"When I look at markets, long-term fundamentals, such as supply and demand, ultimately come back to make the final decision," says Robert Chesler, risk management consultant at FC Stone. "In the short- and medium-term, though, it is the motion that dominates the market and that is what we have seen in the [grain markets]."
Additionally, higher prices in both the grain and meat markets attracted a record number of spec longs that only helped to push these markets higher.
The big story in the wheat market (and arguably the whole grain complex) has been the drought that hit Russia this summer. As you can see in "Waves of wheat" (below), as news of the Russian drought, its subsequent impact on the Russian wheat crop and eventual Russian grain export ban hit the markets, a fire was lit in wheat pushing it from $4.42 per bushel on June 29 to a high of $7.85 3/4 on Aug. 5, a gain of over 77% in a little over a month.
"In terms of a couple of hot button numbers, there was over a 30% drop in Russian wheat production, in Kazakhstan a 33% drop and about a 20% drop in Ukraine," says Rich Nelson, director of research at Allendale.
The potential impact was easy to see. "If we go back to the move up that started in July, we can see that it was dominated by eastern European fear. So what you have is a great deal of physical short covering coming into the market along with speculators that ran in front of them," Chesler says.
Additional concerns in the wheat complex have come from other areas of the world including Canada, which had a rough planting season this year because of too much moisture and more recently faced frost concerns; and the European crop has seen problems arise in both production and quality. Europe has seen less wheat graded as mill quality and more in the lower feed quality. "The bottom line is we had a severe drop in production at the same time as some tight supplies of milling quality wheat," Nelson says.
Despite these problems, supplies are still doing quite well with the September World Agricultural Supply and Demand Estimate (WASDE) putting projected wheat stocks at 902 million bushels, the second highest in more than a decade, if the projection stands. "In terms of the big picture, one of the things we need to keep in mind is that wheat supplies are not actually tight. All these production problems have done is taken us from a burdensome supply picture down to a normal supply picture," Nelson says.
Going forward, weather and geo-political factors are what traders need to watch. Already, Russia has begun experiencing milder weather and at least one lower level Russian official has hinted the Russian grain ban may not be as bad as was previously expected. But that will most likely depend on weather. "They are getting some really good weather right now, and if that persists and they get some good planting done, then they should definitely be able to lift the ban. If it turns back toward drought, the ban could hold," Chesler says.
Other countries are showing an ability to fill some of the holes in the world wheat supply, too. According to Phillip Streible, senior market strategist at Lind-Waldock, Australia’s wheat production may hold the key.
Looking to the markets, the analysts we talked to put the December wheat contract trading in a sideways type of mixed market through the first week of November with support levels around $6.50 and an upper resistance at $8.00.
Corn: It’s all in the yield
As the Russian drought decimated the Russian wheat crop, demand for other grains quickly followed and corn quickly followed the wheat rally. Until the drought hit, many analysts expected record yields, particularly in corn.
"What you had in late June was the perception of perfection in the grain market and that is a dangerous thing. People were looking at record or near-record yields and the weather was perfect in the United States. Then people were blindsided by several factors including the Russian drought, Canadian flooding, Canadian frost and snow, and Chinese frost and snow. The most bearish of all factors, though, became the U.S. yield," Chesler says.
While the Russian drought was not the sole reason for the rally in corn, it was one that added urgency to it. Over the summer we saw corn go from $3.25 per bushel on June 29 to a high of $5.22 ¼ on Sept. 24, breaking through the $5 dollar barrier.
Chesler says the most bearish factor this year has been the U.S. yield. "Tall as corn" (below) shows the U.S. corn yield has continued to grow, almost yearly. At the beginning of this year, the U.S. Department of Agriculture (USDA) projected corn yields to top 165 bushels per acre. Since then, that projection has dwindled, dropping first to 162.5 and then to 155.8 as we went to press. Streible expected yield estimates to drop to 158, which he saw as bullish. The lower than expected estimate pushed the entire complex limit up for two days.
While these factors have worked in favor of corn’s rally, the USDA’s grain stocks report that was released on Sept. 30 threw a wrench in the mix. While analysts were looking for corn to come in around 1.407 billion bushels, the actual number came in at 1.708 billion. This blew analysts estimates out and proved demand has been a little less than expected and production has been better than expected. While it initially sent corn prices tumbling, corn proved resilient.
The $5 dollar mark is proving to be significant for corn as it has straddled that level through much of the rally. "Psychologically, [the $5 mark] is huge. Technically, it doesn’t hold very much significance. Psychology will determine perception, though, and perception will become reality," Chesler says.
While corn prices are much more domestic in nature than wheat, international growers will help determine the direction, especially Argentina.
The biggest factor to watch, though, is the U.S. yield. Most analysts saw a yield of 160 as a "very significant pivot point" determining which side of $5 corn will settle. The dramatically lower yield estimate has corn pushing $6, which should offer serious technical resistance.
Soybeans along for the ride
Shortly after wheat and corn began their rallies, soybeans followed starting at $9.30 per bushel on July 1 and rising to $11.33 on Sept. 27. The reasons for the rally, though, have not been as clear as they were for wheat or corn. "For soybeans, there are no problems at all in either supplies or production, they are simply being dragged up right now by wheat and corn," Nelson says.
Unlike either wheat or corn, neither supply nor production are behind the rally in soybeans. "Shocking soybeans" (below) shows that far from a shortage of soybeans, we are actually looking at a record breaking yield year.
Instead of a supply issue, it seems soybeans have just been pulled in the same direction as the rest of the grains complex. "This is not a bull market being made on supplies. First, this is all based on the idea of fund money rallying into commodities in general, which carries over into beans. Second, it is an acreage argument we are working out," Nelson says.
Those two factors are not unique to soybeans, but they seem to be having the greatest effect in this segment of the market. What is unique, though, is the continued interest China has shown in soybeans. Because of unfavorable weather conditions in China, they have been working to build their reserves to prevent any sort of serious food shortage or crisis from developing, according to Streible. "[Soybeans are] all about China. Soybeans have bounced off the $10 price quite aggressively and that has been very strong support. Chinese buying has really put a floor on this market above all else," Chesler says.
With corn and wheat prices reaching two-year highs, an acreage battle is ready to breakout as farmers begin making decisions about next year’s crop. "There is speculation there is going to be a potential acreage battle between soybeans and corn next year. Initially, when we saw the shortage and rally in wheat, a lot of farmers were indicating they were going to plant wheat this year," Streible says. "[An acreage battle] can drastically swing prices, especially if you are getting an additional million acres getting allocated to certain crops."
Looking to November, Chesler says $10 has proven to be a very strong support level. He expects $11 beans on the expectation that China will stay in the market. Streible is even more bullish with $10.50 support and anticipating $11.25 beans.
Livestock seems to be stuck in a tug-o-war right now between rising feed costs and a rising export demand that is happening in both cattle and hogs. According to Nelson, even though beef production is about 1% higher than last year, the amount of meat actually making it to the U.S. consumer is down about 3-4% (see "Bye-bye beef," below). He points out that this is part of the world food demand story and that the rise has not been from any of the top five countries the United States normally exports to, but rather a number of smaller ones combining to make an impact on the market.
"Exports have been significantly higher this year because, as other grains and meats have risen, countries have been looking in and accepting other meat products like live cattle. With higher grain prices, they are going to look for other ways to get that protein source," Streible says.
Even with the increased export demand, cattle and hog producers face tough decisions for next year as feed prices rise.
"[Producer’s] largest input cost is feed and their largest feed ingredient is corn. With corn at $5 a bushel, producers are probably looking at a pretty dismal profitability picture again next year unless we have some sustained demand and continued tight supply," says Randall Cleland, principal at Tanyard Creek Capital. "If the grain markets don’t have a major setback, guys will make their breeding decisions based on $5 corn. If I’m right, you are going to see a larger slaughter in the short run and much tighter supplies later."
Moving forward, Cleland expects cattle prices to remain fairly flat, but hog prices to move down to the $65-$70 range through the first week of November. The big factors to watch are feed prices, export demand and the decisions spec funds make as we are currently seeing near net record long positions.
Livestock markets were more volatile then the grain sector at the beginning of 2010. With uncertainly in the grains, a sector that plays an important role in the cost of beef and pork production, meat markets will likely continue to produce large swings.
In short, what looked like a pretty boring sector around the middle of year, has proven to be much more interesting. Volatile conditions will likely continue as potential additional quantitative easing by the Fed also must be factored into the mix with supply and demand concerns.