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The Bear Makes a Comeback

14:22PM Oct 02, 2008

We have already lived through a history-making event in 2008 with $8 corn, $16-plus beans and $25 wheat. What's next? In 2008, we destroyed the bear (also known as the forward seller). Many who stored grain unpriced did well if they sold at lofty levels, but I've heard there are still producers who are storing grain. In 2009, the marketer will rise to the top, and it won't be quite as pretty a picture for the cash seller off the combine.

The reasons behind the recent excitement include the following:

-World stocks worked down to historic low levels.
-China and India started to realize their true purchasing potential.
-Wall Street has turned its attention from equities to commodities.
-The sharp rise in oil values from $85 to $150 boosted interest in biofuels, increasing corn demand. 
-The fall of the U.S. dollar from the high 121s in 2001 to its extreme lows this summer at 70.

Overall, grains and oilseeds had a strong wind at their back, allowing minor changes in supply (or a modest increase in demand) to have an overexaggerated price impact.

Now, all of that has changed! The U.S. dollar is on a roll to the upside, the world economy is correcting, effects of the subprime mortgage mess are growing daily, the oil market is in full correction mode and policymakers are working hard to increase supplies long-term. Many of the long funds have taken heavy losses and the excitement of being in commodities has soured a lot of financial players. Overall, the outside markets have turned direction from a strong tailwind to an aggressive headwind.

Each commodity needs to have more aggressive supply corrections or an increase in demand to cause significant upside price advances. Implication: There could be a lot of smoke (trading volatility) but not much progress (flat price rally).

I worry producers will try to market remaining unpriced inventory in the hope of a continuation of last year's fundamentals, instead of the reality (a change in the fundamental trend). While cash-flow requirements will be strong next year because of higher input costs, producers will want to be strong holders of 2008 product clear into next summer.

Don't focus all of your attention on unpriced inventory in the bin and pay little to 2009 sales. If a weather event doesn't occur, the potential exists for significant downside price and basis risk exposure when producers already have significant investment costs in the 2008 and 2009 crop.

As I said, it's not going to be an easy or pretty year. The inability to sell because of the fear of a return to 2008 prices forces producers into some form of put strategy. The problem is, this costs money when other input costs are exploding. In the end, marketing will be done last, if at all.

So the battle begins for producers on how to price 2009 inventory when holding a large portion of 2008 for higher prices—and trying to catch up because of pricing difficulties in 2008. Exceptional financial exposure is developing for the fall of 2009 if we have normal yields and slower demand. The bear is back!

Corn 4
USDA's lower yield of 152.3 bu. per acre in the September report is close to where we thought it would end up. The potential exists for a little more downward adjustment as harvest reports flow in. The problem I see is that for every downward revision in supply, we could see a little lower demand. We should prepare for carryover between 900 million and 1 billion bushels—tight but not explosive!

How many acres of corn will farmers plant next year, when cash rents and input costs are exploding? The current estimate is that it will take every part of a $5 bill to cover all costs and bases. If you want to add risk premium, December 2009 corn futures have to be at least $5.50 and closer to $6 to keep the acres we planted this year. The "talk” is no increase, and we may see fewer acres if farmers move back to a 50/50 rotation.

Bottom line: With the September report, we have reduced the potential of December 2009 corn below $5.50. Buyers need to scale down buying in early October. Set a target of being completely purchased before the October supply and demand report. As for selling, wait until February or March to price old and new crop inventory. The challenge is how to take advantage of higher prices before the seed is out of the bag and before the traditional summer weather-scare markets. You have to sell by March to defend against the summer weather, but don't hold out for higher prices and risk falling below breakeven.

Beans 8
The ranking level of beans would be a 10 instead of an 8 if beans were higher than $14. Focus on selling rallies, rather than being a strong buyer of breaks. The bean complex rallied after the September report but not as much as expected, with yield being lowered to 40 bu. per acre.

While the domestic supply was reduced, the global supply of beans was increased. The word is that the late rains are going to help the late-planted beans, which eventually may increase U.S. yields. I don't know whether I agree, but early Group II bean yields in Indiana are coming in around a solid 55 bu. per acre.

The next 30 to 45 days will bring the best prices for beans. Sell beans off the combine and use strong price gains above $12 to start aggressive scale-up selling of November 2009 beans. I'm concerned that acres are going to be up domestically and internationally next year while demand will be stable to slightly lower. As a result, strong downside price pressure could develop a year from now.

The longer we go without seeing a strong rebound in soybean demand, specifically biodiesel (which is directly tied to crude oil going back to $150 plus), the greater the potential for prices to continue to fall. I'm confident we are going to see the increase in production acres domestically and internationally; I fear demand is not going to keep pace.

Wheat 6

The wheat market has corrected drastically and is now at major technical support levels. If we don't bounce quickly, we could face a year of world stocks increasing, as they did from the 2007 low of 118 million metric tons to 139 million in the September report. Not only did producers around the world respond to higher prices, but many are suggesting production is going to be better than expected.

The wheat trader, however, is fearful of what happened last year. He or she sold too early; then the market exploded and cash contracts had to be bought back at major losses. It will take several years before cash sellers regain their excitement about forward selling. This suggests a lot of U.S. wheat producers will flood the market with unpriced inventory in the summer and the fall.
Bottom line: We have already broken major technical support levels, which means that the wheat market is in trouble. Focus on selling modest 25¢ to 50¢ bounces. If we close back above $9 in July wheat, I would have to suggest that producers adopt a modest call protection strategy.

Hogs 3

Many hog producers have by now experienced a $14 per cwt. decline, which may put them in the red. Subsequently, we are starting to hear of larger operations choosing to throw in the towel.
If there is one thing I know, eventually the fundamentals do matter. If producers start to liquidate their breeding herds but the population base continues to increase, demand will sooner or later force the market sharply higher. This is the good news for hogs. I strongly believe we are nearing the bottom of the market. Feed costs will be on the decline, demand will be stable and supplies will start to tighten domestically. The only long-term storm cloud I see for hogs is the inability to export product
overseas. With the U.S. dollar starting to firm up on other countries' currency and with China showing strong signs of wanting to significantly increase hog inventories, it's going to be increasingly difficult to export our pork products.

Bottom line: Events are coming into play that will put a bottom in the market; the level of recovery, however, will be tied to how strong consumer demand is at home. This, unfortunately, is directly tied to how stable the economy remains.

Cattle 3
The cattle market is almost a carbon copy of the hog and poultry markets. High feed and input costs have put many operations in the red. Nobody is excited about expansion. Liquidation or cutting back is on everyone's mind. When you add in the uncertainty about the economy, the entire production line is thinking, "What can I do to simply survive?”
My concern is we may be heading for a market flush just as many producers elect to liquidate capacity rather than take the risk of continued losses. This sets the stage for near-term weakness but long-term gains. All producers who have short positions in place should sit. However, devise a plan as to how you will remove hedges and protect upside long exposure when the downtrending overhead resistance line is taken out.

Bottom line: Now is not the time to be bearish. It's time for all end users of meat products to look at ways to secure long-term upside exposure.