Price Discovery—Seeking Profit Levels
USDA's January reports always have a profound effect on my price and profit—loss outlook. This year's were no exception.
Not only did USDA's corn production stun the trade, but winter wheat acres were down more than expected and the lowest since WWII, freeing up more acres for corn or beans. Add 3 million Conservation Reserve Program acres expiring, and the market sees too much of everything coming.
The resulting downward price adjustment may seem surprising, but not if we review how we got here.
The 2008 "Bubble." A case could be made that the run-up in grain prices in 2008 was an accident waiting to happen—nothing more than a bubble similar to the energy, housing and stock market debacles that took back four to six years of price appreciation. The weekly corn chart reveals some startling facts that were evident before this past month's blockbuster report and suggest the market may have peaked regardless. Consider: Prices broke out of the pre-ethanol trading range in the fall of December 2008, closing above $3 for the first time in two years, then traded sideways for a year, questioning whether ethanol demand was for real. Then, following crude oil's rise to unsustainable lofty levels, curbing demand worldwide, the chart gapped higher, above $4.30 on the way to $7.50.
The drop in prices was just as steep as the rise, posting a weekly "down gap" near $4.30, the area of the "up gap," leaving a 10-month trading island.
That island tells me that corn above $4.30 to $4.50 in the lead futures contract is unsustainable in today's global environment. We can't feed it or export it, and we may not be able to burn it.
Corn now has $4.30 to $4.50 as stiff resistance, with $3 as a floor. There is plenty we can do with $3 corn.
Looking Ahead. With a possible 2.5- to 4-million-acre increase in 2010 corn plantings, using $3 futures as the worst case in cash-flow projections appears reasonable (see Magazine Extras). Receiving more than $4.50 in the lead futures looks unrealistic in 2010/11. Cash prices will be more important in determining real demand.
Prices of land, rent and inputs could adjust to a postbubble world, as we return to the pre-2008, realistic, 2% to 3% year-over-year growth in feed and foodstuff demand. A market trading on fundamental value, not investment value, may be in the cards.
I went into the January report 100% hedged in 2010 soybeans, 50% in corn, 40% in wheat and 75% sold for 2009 grains. I quickly got to 100% for 2009 and 80% for 2010 using futures and put options and sold July corn calls at $4 and higher. My target of $3 corn futures may not be realized in 2010, but if my analysis is correct, highs made in January should not be violated either. I purchased $3.30 May corn put options and $4.80 May wheat puts on 60%, and I plan to take profits on short futures in April as we enter the planting season. Soybeans appear to have a $2 risk!
Jerry Gulke farms in northern Illinois and North Dakota and has a consulting office at the Chicago Board of Trade. Contact him at firstname.lastname@example.org or (312) 896-2080.
Top Producer, February 2010