Production Destruction Under Way?
The ink was barely dry on my October column before prices broke the two-year soybean uptrend with a vengeance, to levels below my targets. Corn lost its battle with $4.80 and retreated another dollar. Stories surfaced of low levels of farmer selling and end users losing millions by failing to hedge off panic buying of $7.50 corn this summer.
Blame demand destruction, world recession, deflation of commodities in general and the focus on obtaining capital from whatever source possible. Purging markets of excesses normally takes prices below their economic value (cost of production). It may be a matter of time before thoughts of "production destruction" surface, creating another price-volatile year.
There is reason to believe that in the short run, we may reduce the profitability of producing anything as the liquidity crisis runs its course, not just in the U.S. but also worldwide.
Many of the long-only funds have learned a tough lesson: Long-term in commodities can be 30 days, not 365 days. Outside money that once flowed into commodities has vanished into thin air—ask Goldman Sachs!
I have long followed the traditional spec funds, which began selling their long positions to the underfunded short-hedgers, who were blown out of positions due to lack of staying-power capital, and to the end users, who came late to the buying frenzy. This lack of capital will make it much more difficult to turn the long-term focus positive again without a production reduction.
Weather is always the wild card, but until evidence to the contrary surfaces, odds are that a return to a price anywhere close to where we would love to have a second chance to sell could be 12 to 18 months away.
Chart speaks. Technically, corn succumbed to liquidation, similar to what happened to soybeans last month. I often tell producers/traders to "look at a price chart until it speaks to you." The corn chart seems to have a lot to say.
The corn bull market began just two years ago with a breakout above $2.60. Despite bullish outlook for ethanol and expanding world de-mand, prices retreated going into the 2007 harvest on the belief that carryover would be near 2 billion bushels, only to post a preharvest low of $3.20.
Prices gapped higher in December 2007 and never looked back as the market saw the need to buy acres. Corn ultimately peaked at $7.60, posting a major sell signal. The subsequent collapse printed two weekly gaps: one the first week of October that broke a bearish triangle formation, and the second in mid-October on the way to $3.75, for an unprecedented one-month collapse.
Any short-term concerns with harvest could carry corn back up to test the $4.50 area, with $5.25 as a target under more severe production destruction.
Demand dampened. The market proved there is little that can be done with $6 corn, even with crude at $150. With energy prices falling by half, it is unlikely corn can manage more than a 40% rally, to $5.40–$5.85. The exploding dollar (see my Summer 2008 column) hurt our exports, and $5 cash corn doesn't work with ethanol at par ($1.55) with wholesale unleaded gasoline.
If the price capitulation of ag stocks is any indication, suggesting that ag commodities can't suffer similar consequences of "markets gone wild" and retrace all of the 2006-to-2008 upmove might be naive. Is current world demand sufficient to turn our ag markets around before the decade ends and create another acreage battle without perceived or real global production destruction? Only time will tell!
Jerry Gulke farms in northern Illinois and North Dakota, and has a consulting office at the Chicago Board of Trade. Contact Jerry at firstname.lastname@example.org or (312) 896-2080.
Top Producer, November 2008