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Outlook: Topsy-Turvy Markets

October 4, 2010
By: Bob Utterback, Farm Journal Columnist

Sales Index Key
Excellent sales opportunity 10
Excellent buying opportunity 1

Normally, by the time you are reading the October Outlook, many of you are just getting into the full swing of harvest. This year, everything has tended to be early: the lows came in June when you expect highs, and the question now is, will the highs be coming just as producers get ready to close the bin doors? This leads me to ask, is there anything like a normal seasonal in the grain markets or are we destined to trade in the Wild West style from here on?

In retrospect, dramatic and unexpected supply-and-demand events caused this year’s seasonal moves.

First, while we started the year with the expectation of big planted acres in the U.S., spring and early summer rains prevented many producers from following through on planting expectations. This led to an unexpected reduction of planted acres in the June reports. Some producers shifted from corn to beans late in the planting season simply because they could not get corn planted. This set the stage for the late-summer fireworks.

The second event was dry weather in Russia, causing that country to reduce exports and possibly force it to import grain later this year. This has scared end users into worrying about the world supply of wheat, corn and soybeans.

The result is a corn market rally in excess of $1.26, soybeans in excess of $1.61 and wheat in excess of $3.42 when historically one should see weakness due to harvest pressure.

So where are we at now? Corn has gone from a carrying charge market in June 2010 of 39.5¢ to a situation in which December 2010 contracts are now premium to December 2011 by 12.25¢.

January soybeans are 20¢ premium to November 2011 and December 2010 wheat is 10¢ premium to July 2011. This market structure is telling us: “I want your inventory now, not in the future.” It is my observation that great bull markets often end in an inverted carrying charge market. The question is: How long will it take to ration usage and stimulate supply?

In the bin unpriced. The big concern I have is that everyone is now bullish. As one of the last bears, I gave up the last week of August on a big correction. Speculators are long, end users are buying breakouts and I sense a lot of corn and soybeans are going into the bin unpriced in anticipation of a repeat of the 2008 price event.

What has to happen for corn and soybean prices to explode next year? We must first see U.S. corn yields below 161 bu. per acre and a soybean yield below 42 bu. per acre. If this occurs, the stage is set for tight stocks.

Supply reduction is impressive, but we also need solid demand growth:
 

  • The Chinese, and other world consumers, will need to maintain their pace of import buying to rebuild internal grain reserves.

 

  • The U.S. dollar needs to remain weak and motivate currency holders to buy commodities instead.

 

  • The Environmental Protection Agency must confirm that ethanol blends are increased to 15% and blenders’ credits extended.
     

In addition, there are four structural factors to consider before producers see a large price movement.

1. The level of “free stocks” available to the market must get very tight. While there can be grain in storage, it all has to be priced.

2. The world and domestic economy must avoid double-dip corrections.

At a minimum, we need a sideways market or solid economic growth. If this occurs, demand for ag commodities will grow.

3. Producers need to increase acres, but not drastically. We will be hearing the market ask for more than 91 million acres of corn. If producers don’t respond, we are one element away from a price event.

4. The final factor is weather. With the unpredictable weather patterns of 2010, concerns are high regarding a dry-weather event. If we have a dry winter and drought conditions develop, the market will have all the elements in place for a price event.

So there it is. Are we now experiencing an event similar to the fall of 1987 or 1995 (before the 1988 or 1996 bullish price event)? Should you walk away from $4.50 corn and $10 soybeans off the combine for the chance of higher prices in the future? In my 28 years in the market, one of the things I’ve learned is that in the end, all hogs get slaughtered!

Corn 8

Some sellers are thinking about buying back their cash contracts. I say don’t do it! Given the potential for a rally, take what you were going to pay in fees and penalties plus a little risk premium and buy a limited-risk vertical call. For example, buy a July 2010 $5 call and sell a $6 call for as close to 26¢ as possible. This means that you will spend about a quarter for a potential $1 move, making a net gain of 74¢.

Keep in mind when pricing remaining 2010 and upcoming 2011 crops that those making a profit will not go out of business. I hope most producers have already locked up most of their inputs for their expected 2011 crop so they are starting out at a very conservative cost structure. When the market moves above $225 profit per acre over all direct and variable costs, start your sell game plan.

I expect that I will be recommending that producers price a large percentage of expected 2011 production between $4.75 and $5.25 in future sales. I would encourage producers to buy calls next spring against those positions if we start to see a solid price breakout after the March Prospective Plantings report.

Beans 9

Soybeans are being pulled up by the corn price action and the speculative buyers who want to be long commodities. If soybean carryover slips much below 300 million bushels, a price event may develop. There is talk already surfacing that South American production will increase if the continent gets rains. I believe one must expect the market to remain firm until we have a solid handle on the U.S. and South American crops.

I strongly support selling soybeans off the combine. If reownership is desired, use the same type of basic call ownership (buy a July nearby call and sell a deep, out-of-the-money call at the premium level you are willing to spend). Do not focus on selling puts to buy the calls unless we experience a solid $1 or better correction off the highs.

Regarding anticipated 2011 inventory, if you can get profits up to the $200 per acre level, sell. If input costs are around $8, I believe anything above $11.25 in the November 2011 contract must be given aggressive consideration in pricing.

Wheat 9

The Russian situation changed wheat fundamentals significantly to put in a $3 plus price event, but I believe U.S. producers will respond aggressively by planting wheat this fall.

From all accounts, wheat seed is gone! Summer crops are coming out quickly, allowing producers to complete fall seeding, and solid rains will get the crop off to a good start. If all this happens and no other world producer gets into trouble, U.S. wheat prices are in trouble. Rumors are
that producers in the wheat/soybean double-crop region are going to plant more wheat acres. I suggest you price all of next year’s expected production at $7 to $7.50.

Bottom line: The highs are in unless supply gets into trouble. If it does, things will go nuts! If there was ever an environment for a limited-risk strategy, this would be it: Get it priced in the cash and buy a call or buy a put. Please note that because of the expectation of wide basis at harvest and big carryover, I suggest that producers plan to store wheat rather than sell it off the combine.


The information provided is believed to be reliable. There is a risk of loss associated with trading futures and options. Anyone acting on this information is doing so at his or her own risk. Consult your Risk Disclosure Statement before trading. To comment on Outlook, e-mail Outlook@farmjournal.com. For information on risks and strategies or to subscribe to Bob
Utterback’s Internet site or e-mail service ($400 per year), call (765) 339-7704 or e-mail bob@utterbackmarketing.com. You can read daily comments from Utterback after markets close at
www.farmjournal.com.

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FEATURED IN: Farm Journal - October 2010
RELATED TOPICS: Bob Utterback - Outlook

 
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