Price elasticity, in the theory of economics, means that rising prices will reduce demand. Inelasticity is the opposite: price has little effect on demand. In past years of relatively tight stocks, USDA tended to rationalize that rising prices would bring reductions in line with demand. A minimum pipeline supply level was held constant. Based on the agency’s Feb. 9 Supply and Demand Estimates report, there appears to have been a paradigm shift in thinking, especially in corn.
In the face of corn prices rising to levels not seen since August 2008, USDA actually increased demand, lowering ending stocks by 75 million bushels to a level (675 million bushels) well below what analysts believe to be minimum pipeline stocks of 1 billion bushels. The last very tight stocks year, 1995/96, saw usage drop more than 500 million bushels in June, July and August to bring ending stocks to 426 million bushels.
A Silent Message. By lowering the carryout of corn, USDA is basically saying that we either will be able to get by with less than a 1-billion-bushel pipeline supply or that there is no evidence of demand destruction yet. Cuts will need to be made, we just don’t know which sector it will be, or perhaps all demand sectors (feed, industrial, exports) will share the responsibility.
In my opinion, if the latter happens and we just get by this year, we will merely move the tight stocks situation into the next marketing year. If so, the need for solid production levels by major exporting countries is imperative. The U.S., Canada, Europe, South America, Russia and the Ukraine come to mind as exporters. China, an importer of 60% of the world’s exportable soybeans, looms large now as in need of feed should its summer corn and wheat crops fall short.
Time Will Tell. The degree of demand rationing is an ongoing process that will formally be measured in quarterly reports on March 31 and June 30. With time running out to bid for more acres, the shot across the bow by USDA was noted by the corn trade with new post-report highs.
With La Niña alive and well, odds are increasing that a stocks-rebuilding phase may not be just a one-year event. I find it interesting that when the ethanol mandates were created, we didn’t use our existing surpluses as an energy and food reserve just in case. Of course, such an act was not in keeping with our surge into a free-market system, as it would be touted as a cap on prices. It seems odd that we have become so complacent as to believe we wouldn’t ever be significantly affected by food versus fuel.
Price Connections. The job ahead of planting enough acres with good growing conditions to produce trendline yields will not be easy, requiring a "weather" premium. The political malaise in the Middle East promises to add another element of uncertainty affecting the price discovery process.
Corn, in contrast to 2008, has disconnected itself from crude oil as this bull market thus far has been about food and feed, not energy. Should crude oil prices surge, we will have a new price discovery scenario, and I dare not speculate as to its outcome.
Not only will we find out on March 31 how successful price has been in curbing demand, we will get the first survey-based estimate of planted acres. USDA’s baseline acreage numbers released in January were close to my personal guesses in February’s Market Strategy column, with both requiring significant increases in total planted acres. Cotton’s parabolic surge may have been a precursor of what is to come, should corn and soybean acres prove insufficient.
What to Do. With a surprise likely coming in the USDA report at the end of this month, some downside protection is warranted in corn and beans. With prices in the stratosphere, I will initially use cash contracts to cover 20% to 40% of production to lock in prices without the headache of margin requirements. I will use futures/options for additional coverage. Options are not cheap. However, not using some downside protection within your comforts zone is poor management.
If stats show demand destruction, you are covered. If there is insufficient reduction in usage, the upside potential will be significant.
- March 2011