Make Sure You Are Buckled In, These Markets Could Get Extremely Volatile!

Published on: 16:23PM Jun 30, 2010
Sorry for the long delay since my last comments...I have been traveling around with my son and his summer baseball team. I will certainly miss these summers together and the games under the lights when all of the kids finally move out and on to college.
As for the markets...what a wild ride today has been! For those of you who have started working with us in the past few months, your timing could not have been more impeccable. We have done extremely well and have been generating some terrific revenue in the grains and livestock markets. We have had numerous option strategies that have produced big returns in the past few months. 
Looking at today's big USDA report, you had to be surprised by the large reduction in corn acres. We certainly were surprised to see these numbers, but were by no means caught off guard as we had recently sold puts as part of a more complex re-ownership strategy that we had just put in place. Having watched the market break more than 35 cents in the previous sessions and demand levels staying strong, we estimated the downside exposure and risk at the time had to be somewhat limited for a short-term play. Our analysis paid off and we hit a big home run for our clients in today's trade. 
The question I am sure everyone is asking is, Where do we go from here? The report today certainly has the makings of being a complete game changer, but will we see the follow through to make it happen? 
Before you look at the facts, you have to recognize that the USDA in the past several years has almost always raised their acreage estimates for corn in this June 30th report. Not only did they NOT raise their estimates this time around, but they lowered their estimated total corn acres planted by almost 1 million acres. In addition, ending stocks came in at 4.310 billion bushels, which was almost 300 million bushels below many expectations.
The planted acreage number is big, but I think the ending stock number could ultimately prove to be of even more importance. With the stock number falling, you have to believe we are continuing to see better than expected demand for corn. 
You don't have to be a math whiz to figure out that if we start with less corn than we had anticipated and plant 1 million fewer acres than we had planned on planting, we should end up with a lot less corn. In the simplest of terms, that is exactly what traders are thinking and that is what ultimately shocked the market and caused the limit to move higher. 
From here, we have to start asking ourselves some tough questions and try to fill in a few of the blanks. Do we think the report is accurate in its drastic reduction? Will the USDA revise these numbers? Will they drastically raise yield estimates?  How does this all play out if we have a weather problem?
Let's assume the report is accurate and you reduce the number of planted acres by 1 million acres. Using the USDA's current average yield estimate of 163.5 bushels per acre, you have a reduction in their annual guess of 163,000,000 bushels. That is a significant amount of corn.  
We now have to determine what they will do with their current yield estimates. They currently have penciled in 163.5 bushels per acre. I believe they will certainly be forced to raise this number. If you figure last year we were at 164.7 bushels per acre -- and from what I am hearing, many areas have had some very optimal growing conditions up to this point -- it would surprise me not to see this number adjust higher. 
Just for argument's sake, let's assume they go nuts and raise the yield to a new all-time record of 166 bushels per acre. Given the recent reduction in total number of acres, we would still see our ending stocks slip to 1.365 billion bushels and be looking at a very tight stocks-to-usage ratio for the coming months. 
As you can see from the data, even if we revised the yield higher than 166 and went clear up to 168 bushels per acre, when you factor in the lower beginning stocks and the lower number of acres planted, we would be just a little over 1.5 billion bushels in our ending stocks...still tight. 
With all of this bullish data in place, you have to believe we are headed significantly higher. Proceed with caution!
I urge you to be only cautiously optimistic. I understand and know what the fundamental data is telling us, but I have also traded these markets professionally for 20 years and have learned to look a little deeper than the obvious. 
Longer-term, I certainly want to be bullish this market, but I am just not certain the lows are in place just yet. Without a major weather issue or some help from the outside markets, I could honestly see prices falling back and making new lows during the next couple of months. 
To begin with, I am not certain if the USDA's recent estimate and drastic reduction in acres will hold water and stand the test of time. It would not surprise me to see some type of revision to these numbers in the coming weeks. I also believe we will see some additional farmer selling and heavy pressure as we rally up on the board.  
You also cannot discount the recent global economic struggles and fears of slowing economic growth across the board. 
As the funds continue to manipulate and control the price action in these markets, you have to realize the stakes have been raised dramatically and we no longer trade off of simple supply and demand numbers.   
China allowing its currency to float freely on fear of U.S. and global debt continuing to mount with no light at the end of the tunnel will be of major concern in the coming months. Will China continue to buy U.S. debt paper? How will the U.S. dollar respond versus other major grain-importing currencies? If China slows dramatically, how will it affect crude oil? How will that ultimately affect ethanol production and consumption? How will the eurozone issue play out? Will the Gulf Oil leak start to drag on the economy? How will the recent jobless claims and latest wave of mortgage defaults play out?
The questions are certainly many, but you have to recognize their importance, as the biggest players in the grain and livestock markets are now glued to the outcomes. 
I am blessed to have been on the right side of the market this time around, but who knows what tomorrow may bring? I urge you to strongly consider all available data and, more importantly, the direction of the outside markets before you jump in with both feet. I am excited to see the bullish news, but I am going to proceed very cautiously until I see more confirmation in other key areas. 
As for beans, I continue to advise selling on the rallies. The USDA report showed ending stocks about 25 million bushels lower than traders were expecting. Planted acreage, on the other hand, was raised by just over 700,000 acres. With the planted acreage numbers being revised higher and the stocks being lowered slightly, the report had no real dramatic emphasis. 
I still believe that you have to be fearful of the ending stock outlook and just how many total beans we may end up with. If you take an average yield of 44 bushels per acre, I believe it pencils out to somewhere around 450 million bushels in ending stocks. If we leave yield at 42.9, the ending stocks still come in over 350 million bushels. That number is huge and would be the largest in the past few years, and a major increase from last year's levels. 
The weight of the ending stocks and the current worries on the global economic front leave very little hope for any sustained rallies.  
I desperately want to buy this market for the long-term haul, but unfortunately, as in the other markets, I think lower prices are ahead. You certainly have to like the long-term potential, but with thoughts that wheat will continue to lose acres to corn and beans in the coming years and the recent news that Canada has lost almost 10% of its recent wheat crop to severe weather problems, I just don't believe we have seen the bottom in prices just yet. The USDA report has only confirmed my thoughts, as the ending stock numbers came in about 30 million bushels higher than trade expectations, and the planted acres for spring and durum wheat were revised higher. Certainly wheat will follow corn and will be up big today, but it would not surprise me to see us make one more push lower as this market will attempt to put in new lows before we head to higher ground.  
In summary, I believe using a multitude of two- and three-way option strategies will be the play in the coming months and should help producers generate additional income and revenue as these markets hit heavy resistance up above. Look for this recent rally to be fairly short-lived across the board unless we get additional support from the outside markets or a significant weather scare in the coming days.
If you need any help or want more specific information regarding our current positions and/or strategies, please give us a call at (816) 322-9800.