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Outlook: A Long Hard Grind

02:35AM Aug 27, 2014
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The bear is awake and has sent prices well below many farmers’ production costs. The issue is not how deep the correction will be, but how long it will be! The grain markets have not experienced a multiple year bear market since 1997 to 2001. Many believe global demand will quickly bail out prices, and the bears are getting overly excited.

If a global producer does not experience a significant yield reduction by mid-2015 all unpriced farmers have painted themselves into a nasty corner. In the end, the market will not turn bullish until the bins are empty, acres are reduced, demand is stimulated and yield reduction weather concerns start to mount. All of these key variables for higher prices will take time and patience. 

Corn 12345678910

The biggest part of this year’s bear market is now factored into the picture. The cash market will put the bottom in during harvest as farmers are forced to make room for a bin-busting crop. If the U.S. corn yield is more than 170 bu., lead month futures will find support between $3.25 and $3.50.

Sales Index Key

Excellent sales opportunity...10

Excellent buying opportunity...1

After harvest, the real issue is farmers getting extremely attached to their crop because the prices are well below total costs. To get cash flow, I would not be surprised to see farmers put corn under loan and then get their crop insurance payment and government check with the new farm program to simply get by. The problem is that little will be done with the 2014 crop until next summer. This sets the stage for real downside price pressure if we see trend-line yields on 90 million planted acres.  

I know low prices will stimulate demand, but it is not going to explode. Livestock and ethanol farmers are making good profits. Granted, they could expand, but I see only modest interest in doing so. Domestic usage will be stable to slightly higher, but nowhere near what needs to be seen to use up excess inventory. This places a tremendous burden on exports. China appears to be experiencing a solid crop, so don’t expect any major demand surge. 

With balance sheets still very strong and a tremendous amount of on-farm storage, I fear farmers believe they can just wait out the bear market. Don’t be surprised to see a range bound market well into 2015 with the risk of the deferred contracts falling to the nearby price if we don’t see significant acreage reduction next spring.

Getting anticipated 2014 and 2015 crops priced at today’s levels will be extremely difficult. If we have trend-line yields next summer, prices will likely get very, very low next fall putting in multiple year lows.

Beans 12345678910

As I write this outlook, the soybean market still has time to see a rally in late August if the dry conditions persist. If August rains develop, the possibility of yields stabilizing on increased acres could bury this market. On top of this, South American farmers have already announced they will plant more soybeans. The final nail in the coffin will be China deciding to shift a few more acres away from corn to soybeans.

This all suggests that, with the potential for a jump in stocks well above 400 million and possibly 500 million, the darling of the grain and oilseed market will become the dog! The record high prices of 2012 have done exactly what markets should do—rationed usage and stimulated global production. How low and how long does the market have to go to build back demand and reduce supply? I don’t believe it will be done in one marketing year. Balance sheets are just too strong. I fear two or maybe three years will be needed.

The pressure is on farmers to make some hard decisions now—whether to sell aggressively to protect current values or wait and hope for a weather event to bail out the market and hope it does not hit their farm. 

Wheat 12345678910

Wheat has taken a big hit alongside corn and soybeans, but we are nearing value levels. There are signs some European and Indian farmers will not have a bin busting crop, but I don’t see a fast bounce off the lows with corn and soybeans under so much pressure.  

If anyone is storing wheat, I assume they rolled to the December contract to capture carry. Consider moving from a straight futures position to a vertical put strategy to keep some downside protection but reduce upside risk exposure. 

As for anticipated 2015 production: Prices are at levels where if the crop is sold, the farmer is locking up a loss. Buy September 2015 calls and sell out-of-the-money puts to help pay for the positions. This can help insulate a seasonal cash selling strategy from January to March on winter injury. If the corn rakes in trend-line yields next year, corn will pull down wheat prices. Timely sales will be essential to keep 2015 losses to a minimum.

Hogs 12345678910

Hogs have had a tremendous flat price rally. Three big questions exist: 

1. Has all reduced inventory moved through the market? We’re getting to the end of the PEDv reduction. 

2. Will it repeat next year? This is the immediate issue. Contracts for December 2014 and beyond are discounted to nearby contracts in anticipation of getting back to normal production. There is big risk on producers. If we see another disease outbreak, the spring and summer contracts will respond. It is critical to have a limited risk selling plan, such as long puts rather than straight short futures or forward cash contract sales. 

3. How fast will hog farmers react to low feed costs and start herd expansion? There are rumblings of construction; is it new expansion or updates to old buildings? 

It is just a matter of time. Remember back in 2012 how corn farmers thought prices were going to stay firm forever? Look at what their experiencing now. The same cycle will occur for hog farmers; devise a plan to protect expected production for the last half of 2015 and most of 2016.

Cattle 12345678910

Fat cattle demand is not being rationed as fast as many believed it would. It is a testimony to how much the U.S. consumer still likes beef. 

Exceptionally strong beef values have moved the feeder cattle market to record levels. The net result has been a slowdown in cattle placements on feed, as backgrounders are betting on improving pasture conditions to keep the cost of gain down.

The problem facing producers who feed out fat cattle is buying placement feeders at record levels. Although this is offset by lower feed costs, it is critical demand remains stable. I don’t believe anyone can bet on that.

Consider buying in-the-money puts rather than selling futures or forward contracts. Buy as deep-in-the-money as possible to reduce any hint of time value decay and to be as close to a short futures position as possible. The biggest advantage to this strategy is if prices rally, it is possible to improve the bottom line; if prices drop, inventory is protected.

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