The agriculture complex offers unique opportunities for traders in the summer that often are not seen in other markets. There is a lot of information for the market to digest as it focuses on both the crop left over from the previous year and the developing new crop in the ground.
Changes in the information flow from either end can cause sharp price moves. Here is a roadmap of some of the possibilities — and pitfalls — for summer grain trading using fundamental analysis.
Perhaps most important is knowing the operative marketing year of what you are trading. The U.S. Department of Agriculture (USDA) starts the corn and soybean year on Sept. 1 and ends it on Aug. 31. The wheat marketing year runs from June 1 to May 30.
As of early summer 2013, the trade is in the last quarter of the 2012 crop. Traders are monitoring changes to current levels of domestic usage and exports to help determine the Aug. 31 level of “ending stocks.”
Normally with only one quarter left of the old crop marketing year, the trade’s focus would be on new-crop production expectations. In this year particularly, with tight supplies from a drought experienced during the previous season, the trade is monitoring old-crop demand closely.
The single biggest mover of grain prices is the annual change in supply — and ongoing fluctuation in that supply as time goes by. What makes summer grain trading so exciting and potentially profitable is that the bulk of that question will be decided in the short time period when weather really matters. The phases of grain development can be broken up into three parts: Planting/early vegetation, reproduction and fill/finish.
For corn, more than 50% of yield is determined in the small window of time in July called pollination. Cool temperatures and adequate moisture during this time are beneficial. Hot temperatures and little rainfall are a detriment. As can be seen in “July through time” (below), temperatures during this critical period can vary significantly from year to year.
For soybeans, the key yield development phase is in August. Trading during this period is both challenging and volatile. Not only does this small window of time determine a large portion of the fall harvest, but meteorologists are quick to point out they have a tough time pinning down a forecast during the summer.
The newest frontier for grain market research is tackling yield estimation from a statistical basis. Modern yield modeling research, based on the application of proven statistical techniques, provides a clearer and more valid basis for estimating production and price changes during the emotional summer price swings. For grain trading pros, this represents the largest opportunity for solid data mining. For the typical trader, understand that statistically averaging weather between April and September will return trend yields for corn and soybeans. Deviations from average weather, at various phases of development, will give either above or below trend yields. The challenge is measuring the deviation and forecasting the effect.
The current marketing year provides a good case study for the importance of yield expectations. Given the severity of the 2012 yield decline, it is understandable for traders to be skeptical of 2013’s yield potential (see “Yield undone,” below).
Long-term drought maps still show moisture deficits remaining in the western corn belt. However, weather research shows that carry-in soil moisture deviations have little influence on each year’s yields. The past two significant moisture deviation years (1983 and 1988) are perfect examples. The 1983 season was severely wet, while 1988 was a drought of similar severity to 2012. In each of those years moisture deviations remained through the summer of the next year — just like we are seeing right now. The yields for those two years were hardly abnormal, however: Yields in 1984 ended 2% over the year’s projected trend value; yields in 1989 ended 3% over that year’s projected trend value.
Continued increases in world demand have exaggerated the price impact felt from recent supply problems. Consumers in developing countries have seen sharp increases in purchasing power and are spending it on food choices.
Oilseeds are the main agricultural area to feel the impact of higher world incomes. Per-capita world demand for vegetable oils has grown 17% in the past five years (see “Insatiable,” below). This is on top of normal population growth, so it is highly significant. Any rebounds in world soybean production in 2013 only will be able to ease the tight supply situation. It’s doubtful there will be burdensome oilseed stocks.
For corn and wheat, the situation is different. Demand simply is not at the same levels. Producers still have the potential to outpace world demand.
One of the more interesting plays for corn is its use as a fuel source. (For more on this topic, see “Energy leaders and followers.”) Roughly 9.5% of the nation’s gasoline is ethanol. That’s significant because ethanol production makes up 40% of the nation’s corn demand.
In previous years, sharp rallies or declines in energy prices helped to raise or lower corn prices, and it’s likely this will continue. However, in 2013, this price relationship may not be easy for the beginning grain trader to follow because of the decline occurring for gasoline as well as limits to ethanol blending. This means the normally positive relationship between energy and corn prices may not hold true.
Spread trades involve buying one contract and selling a related contract to profit from changes in the price differential between them. In grains, many traders forgo outright long or short positions in futures contracts for the opportunities uncovered in spreads.
As with many other aspects of these markets, the operative spread trades change with the seasons. During the summer months, one of the more popular trades is playing the changing supply perceptions between old crop and new crop marketing years. For corn, this is done using the July and December contracts. For soybeans, this is done with the July and November futures.
Another opportunity — popular in supply deficit years such as 2013 — is the interplay between the old-crop months. Traders will watch usage of the remaining 2012 crop and decide whether there will be enough to get by, or if some last-minute price premium is needed on the last of the old-crop contracts. An earlier- or later-than-usual harvest also will help drive this price squeeze. For corn, this can be accomplished with the July and September contracts. Soybean traders will be watching the July compared to the August and September contracts.
As the crop develops during July and August, the trade will begin to gain confidence over coming fall supply expectations. In years of adequate supplies, the market encourages producers to keep the bulk of supplies off the market. It generally moves into contango, which is where deferred contracts trade at premiums to nearby. A large harvest will encourage large premiums in the deferred contracts. A small harvest generally makes for narrow back-month premiums. In extremely tight supply situations, there even will be a discount in the deferred contracts.
For corn traders, watch the premiums that the March, May or July contracts hold over the harvest contract, December. In wheat, the back months of September and December are assessed with respect to the harvest contract, July. Coming from years of experience, soybeans rarely see premiums past the January contract compared with the harvest month, November.
Confused as to why there are three separate wheat contracts traded in the United States? Each of them is key and, most important, their interplay can offer profitable opportunities for traders.
The Chicago and Kansas City contracts are both winter wheat contracts from separate geographic production regions. Almost 75% of U.S. production comes from winter varieties that are harvested between June and July. The Minneapolis contract is a spring wheat contract that is harvested in August and September.
It is popular to trade one contract off another as changes in rainfall in one region of the country may expand or contract production compared to others.
Weather is the top issue for the late spring and summer months. If conditions are near normal, expect a sharp rebound in corn production and a moderate rebound in soybean production for 2013. This will complete the market’s perception of 2013 as a transition year. If weather worsens over this period, the trade will be eager to re-price new-crop production.
It’s important to monitor the six-to-ten day forecast from the National Oceanic and Atmospheric Administration (NOAA), the government’s weather agency, for updates each afternoon (available at: www.cpc.ncep.noaa.gov/products/predictions/610day/).
Another popular tool is the NOAA’s monthly update of the long-term seasonal outlook (available at: www.cpc.ncep.noaa.gov/products/predictions/30day/).The next updates will come on June 20. It was this NOAA update, on June 21 of last year, that helped to ignite the 2012 grain rally.
The USDA issues many helpful reports for traders to monitor. Every Monday afternoon, the Crop Progress report updates weekly changes in crop conditions. Once per month, the USDA issues the closely followed supply/demand report (WASDE). The next update for the WASDE report is on June 12.
Through these monthly reports, the USDA publicizes its view of the changing old- and new-crop supply picture. On June 28, the USDA will update its view of acreage as well as tell us how much of last year’s small crop is left over as of June 1. Because the March 28 update on old-crop stocks was such a market mover, expect a lot of interest on this one.
Those who closely follow the changing old- and new-crop pictures may be able to see some golden opportunities over the early summer. One note of caution: If you are trading from a fundamental approach during the summer, be ready to accept that conditions can, and will, change quickly — and they easily can change against your outstanding positions. As with all bad trades, accept when that happens and move on.
Rich Nelson is the chief strategist for Allendale Inc. His daily analysis can be accessed via www.allendale-inc.com.