While grains have been traded as long as they have been grown, the modern grain futures contract has been around for about 150 years. In that relatively short time, grain futures trading has grown and evolved from a domestic weather and supply driven market to one driven by global macroeconomics and production.
While financial contracts have become the most heavily traded futures contracts by volume, grains still are what many people think of when considering trading futures. Jokes abound about traders being worried they will end up with a truckload of corn on their front lawn. Grains hold a special spot, and understanding the factors unique to this market ultimately leads to success.
As in all markets, supply and demand are the primary drivers, but those can be affected by weather conditions, emerging markets, crop conditions and even exchange rules.
WeatherWeather always has been a major factor in grain trading because it affects everything from planting, to crop condition, to harvest, to yield. This is distinctly different from other markets like financials and metals in which weather has a marginal impact.
For grain traders, though, weather forecasts give a glimpse into what may happen to the supply of grains come harvest time. Experience teaches us, however, that forecasters hardly are infallible. "When you look at five different weather forecasts, you’re probably going to get five different opinions. You’re not looking for them all to agree with one another, you’re looking at how the forecasts are changing," says Helen Pound, senior market analyst at Penson Futures.
To that end, she says to focus on changes in weather trends and don’t stick to just what one forecaster says. "You’re not looking for which weather forecaster is the truest or most accurate, you’re looking for a general sense of how the weather forecast is changing," she says.
Also, weather impact varies based on other factors, both environmental and more traditional. Soil moisture levels are a key factor. A crop will withstand drought conditions longer if there is adequate moisture going into the growing season. Groups such as the European Space Agency (ESA) use satellite imagery to provide evidence of soil moisture for the United States Deparment of Agriculture (USDA) and people in the trade to help in hedging their production.
Strong inventories from the previous growing season — or carryover — will dampen the affect of adverse weather, whereas low carryover from the previous year will make the market more sensitive to anything that can affect yield.
Like most of the modern world, grains have taken on a global scope with multiple growing seasons around the globe. Consequently, traders also need to be aware of weather patterns and soil moisture levels around the world to fully grasp how the supply picture changes. "With South America becoming such a major soybean and corn producer, traders not only have to watch what is happening here in the spring and summer, but also what is happening there in the fall and winter (their growing season)," says Mike Zarembski, senior commodity analyst at optionsXpress.
Extreme weather problems in any part of the world can have a dramatic effect on grain prices. Just last year, Russia and Eastern Europe experienced severe drought conditions that resulted in Russia stockpiling and not exporting any of its wheat crop. The result was a run-up in the price of wheat futures traded at CME Group (see "Scorched earth"). "Traders need to know what is produced in each region of the world; Russia was big with wheat last year. Because this is a global grain market, if one area is having difficulties, it could spur price increases in another area as they take over some of that business," Zarembski says.
Also, changes in price can affect planting intentions. If a farmer can make more profit in corn than soybeans, he will plant more corn and this will eventually play out in price.
Crop reports
Unlike metals or energies, grains are renewable resources that are replenished seasonally throughout the year from different parts of the world. No matter where a trader is located, this can create some confusion where old-crop (the previous year’s harvest) is being traded at the same time as new-crop (the upcoming year’s harvest). "The thing that is special about the grain markets is that it is a commodity that has several seasons to it. It has a planting, growing, harvesting and marketing season. You have various months you are trading that correspond to various things that that happen every year," Pound says.
Old-crop and new-crop grains move on different fundamentals. "It’s almost like trading different commodities when you go from trading one crop year to the next. That also gives a lot of spread trade opportunities," Zarembski says (see "A couple months’ difference").
Because old-crop already is harvested and in storage, it mostly is a fixed supply and changes in demand primarily drive the price. According to Pound, this easily can be tracked by following supply/demand and carryover in the World Agricultural Supply and Demand Estimates (WASDE) report published by the USDA.
But even this has variations. Chip Flory points out in "Southern fried corn" that Southern states are planting more corn, which because of its earlier growing season, could be counted in old-crop figures.
"I like to take the carryover at the end of the year and divide that by the total usage for the year and get a ratio. If the ratio is small, I know we have a tight supply/demand balance; if the number is large, then we have an abundant supply/demand balance," Pound says (see "Too much or too little?").
Additionally, emerging markets are putting a greater strain on the available supply as standards of living are rising around the world.
Conversely, new crop very much is influenced by factors that may affect the available supply in the future. While weather in general is a factor, its impact can have different effects depending on the time of the year. Early in the year, traders watch prospective plantings to see how the crop is going into the ground; later it is crop condition reports and still later harvest reports.
While food production or livestock feed generally have been the main use of grains, they increasingly are being used in other ways. Oats are used in cosmetics, soybeans in crayons and wheat in postage stamp adhesive. No alternative use is greater than fuel, though. This especially is true of corn in the United States and wheat in Germany (see "Move over Bessy").
"Look at what is happening in crude oil prices. If there are high energy prices in oil, and grain prices are a little more moderate, then production of ethanol may become more profitable and may spur increases in grain demand for ethanol production," Zarembski says. "It is putting another demand stream on these commodities that really wasn’t there 10-15 years ago."
Finally, one other factor new grain traders need to be aware of is the presence of daily price limits in each of the commodities. "The grain markets are one of the few markets left that still have daily price limits. Those really have gone by the wayside in the energies and metals where, even if they have limits, they are very high and only last for a few minutes. Grains still have hard daily limits that will expand," Zarembski says.
This is an important reminder because it could be very easy for a trader to get stuck in a position if the market is moving limit-up or limit-down many days in a row.
Grains have been traded a long time and are a market that has continued to evolve with the world. People need to eat, and pretty much all foodstuffs can trace their way back to the grain market in one way or another.
While other markets may be sexier to trade and appear more significant, food is a necessity of life. While some claim we have gotten into wars over oil, it is the crop failures and resultant food inflation that to a great extent is driving the "Arab Spring" movement that has tossed two long-standing governments out of power and is challenging several more.
