While an expected record crop has pushed grain prices lower, it will take time to translate to livestock, and the dollar rally throws a wildcard into the demand picture.
The strong U.S. dollar (NYBOT:DXZ14) has put the United States at a disadvantage to most of its key competitors. The U.S. economy has stabilized when compared with Europe. The Federal Reserve has moved to end its easy monetary policy. Political tensions run across several continents. Now that harvest is nearing completion the trade’s focus will shift from guessing supply to the question of moving the product. U.S. dollar pricing will play a key role in this issue for the months ahead (see “Dollar strength raises prices,” below).
With good weather we can grow a good crop. With great weather we can grow a record crop. Over the past 40 years we have broken trend yield by 10% or more five separate times. As the last instance of this feat was in 2004, we were due. Every one out of eight years we are due for record yields. While this is a record crop, we can’t say it is burdome on a nationwide basis. Because we lost acres this year, this only represents a 5% increase in production.
The question now turns to how the market will take these supplies. From 2005 to 2011 ethanol was a superstar. Blenders were struggling to secure supplies to meet the Federal mandate. That situation has changed. We are now producing above the EPA requirement with the market relying on exports to move the excess product. This means corn for ethanol is dependent on low Brazilian exports, U.S. dollar values, ethanol pricing and corn pricing. The shocker for the grain industry is that ethanol will be of almost no help in alleviating these heavy corn supplies. The fall in ethanol prices has more than offset the lower corn prices. In early September ethanol producers were seeing profits of 50¢ per gallon. Currently it is only at breakeven. This is the worst margin situation in more than a year-and-a-half.
The “big” question mark for traders here is a category of demand that we don’t have any short-term government data on: feed and residual. We have to consider that U.S. Department of Agriculture’s calculation of this category is dependent on both livestock numbers as well as quantity fed per animal. Despite another expected year-over-year decline in beef production that will be offset by the gains made in chicken and pork. The USDA’s current assumption of a 1% increase in numbers is adequate. In the previous five years where yield exceeded trend by over 10%, we saw an average quantity fed increase of 5.0%. The USDA’s current estimate of a 5.6% corn per animal unit gain is very reasonable.
We have a mixed stance on exports right now. This new crop year started without the interest from China. China’s ban on U.S. corn and distillers grains is a problem for us. That is a missing category of demand that would have taken almost 200 million bushels this year. On the one hand China has a burdensome supply domestically. Even with a large supply, after the government reserve program is considered, it is just not large enough. Their interior pricing at this time is $11 per bushel. As it stands now without China’s participation, and with a strong U.S. dollar, and with many world feed buyers waiting for lower prices, export sales of corn are running 1% behind last year and 2% behind the five-year average for this date. This is despite a record crop (see “Missed opportunity,” below). Any changes in three factors could add support to this market.
Traders should monitor the charts for a fall low in October or November. Our downside target for this move has been filled. After the low is confirmed we cannot argue with an eventual moderate rebound in the March to $3.80. Other trades to consider over the winter would be new crop/old spreads playing on the idea that 2015 production may be smaller.