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Scything Up the Grain Markets

Note: This feature length cover story by Chris McMahon originally appeared in the November 2008 issue of Futures Magazine.
Link to original @ Futures Magazine

Scything Up the Grain Markets
During planting season, the grain situation looked grim. Inventories were perilously low and large agricultural production areas were drought stricken. In the Midwestern United States, cold wet weather delayed corn and soybean planting, then punishing rains followed. Flood damaged fields and food riots were fixtures on the evening news and grain prices skyrocketed. Then something miraculous happened: The markets worked.

Spurred by high prices, farmers worldwide increased acreage, and despite the fact that demand continues to increase faster than production, grain prices began to moderate after peaking in July. Growing conditions were near ideal in the United States and according to the Sept. 30 USDA quarterly stocks numbers, there will be 1.624 billion metric tons of corn, compared to 1.304 billion metric tons last year; and 205 million bushels of soybeans, down from last year, but far outstripping expectations of 144 million bushels.

"The bean number was much higher than expected due to the USDA revising 2007 bean production higher by 91 million bushels to 2.676 billion bushels," noted Victor Lespinasse, of

"Collectively, those inventories are at the same level as they were in the mid 1980s. But in the mid 1980s, we had 2 billion fewer mouths to feed," says Gavin Maguire, director at EHedger LLC. "That's why we are going to see huge price swings in these crops."


Last year, wheat demonstrated this same dynamic. "Prices went absolutely ballistic because we had two consecutive droughts in Australia; we had problems in the Ukraine; in the U.S. there was a freeze on Easter. All of these things had greatly curtailed global output and prices responded," Maguire explains. And then, in response to that high price, wheat growers planted unprecedented amounts of the grain.

"No matter what happens, we are going to have plenty of wheat around," Lespinasse says. World wheat production this year will be a record 676 million tons vs. 609 million tons last year. However, crops in the Southern Hemisphere remain vulnerable to drier weather, which could trim those numbers. Already the International Grain Council cut its world wheat production estimate by four million tons to match the USDA's. With so much supply, he says wheat prices will trend lower.

Winter wheat is planted in November, and the question is whether wheat prices will weaken enough between now and then to cut down the planted acreage.

One increasingly popular strategy for increasing farm income is to plant winter wheat and then double crop soybeans, Maguire says. Bean yield is limited, but for the past two years historically high winter wheat prices have more than made up the difference. "They can't do it with corn; they get about half the yield of full on bean production, but given the high prices of beans, they have been delighted by that." In the last week of September, farmers were getting $7.70 per bushel for winter wheat. "If farmers are looking at the past 12 months they may be disappointed; if they look at the past 12 years, they may be delighted. It has almost no input costs," Maguire says.

Darren Dohme, trader and managing partner at R.J. O'Brien & Associates LLC, expects wheat acres will decrease and the corn/wheat spread will narrow. "July wheat may rally back to $8.50 or $9 this winter as it fights with corn for acres," he says. "If it loses more than 2 million acres, it will go to $9," Dohme says. "Farmers want to be good sellers at the $8.50 level in July futures," if 61.5 million acres are planted.


Unlike wheat and rice, corn and beans are produced in a limited geography. The also are planted on the same schedule and battle for acres as a result. The ratio of bean acres to corn acres then acts as an important determining factor for production, ending stocks, carryover and ultimately price.

"Corn is used primarily for feed for animals, and as the global middle class continues to consume more meat, the demand for corn is going to remain on a long-term rising trajectory," Maguire says. That will underpin prices at a higher than historical levels, but we are unlikely to see the sort of fireworks we saw early this spring, which were caused by production problems and speculative leverage, he adds.

"Once the market realized the flood damage was not as bad as expected, the market peaked in early July right up against that $8 level, and then retreated to $5.05," which likely will be the seasonal low, Dohme says. Flood damage was limited and while some nitrogen and fertilizer was lost, the new corn hybrids are proving very tolerant of tougher weather conditions. "We are hearing of a lot of 200-plus bushel yields out there for early harvest, where you thought they'd be 160, 180," Dohme says, and warmer weather in early fall will help accelerate maturation.

Andrew W. Waldock, principal of Commodity and Derivative Advisors LLC, is concerned about the crop's quality. "The corn looks good from the road, but once you start peeling it back it's clear it's not going to produce the yields we have been expecting." He also notes that while the grains sold off generally, corn failed to make new lows during the financial panic in late September, and that a breakout above $5.67 would create a bullish double bottom. "At 30% to 35% off the highs, it's a classic retracement setup." In November, he says corn could move to or through $7 per bushel and possibly touch $8.

The 2009 crop likely will contend with higher input costs and a tighter credit situation. Corn fertilizers are far more expensive than last year. At maintenance levels, Dohme says diammonium phosphate fertilizer (DAP) now costs a farmer $135 per acre, whereas two years ago it cost $45 per acre; and anhydrous ammonia now retails at $156 per acre. Two years ago, it was $75. If those costs increase, they could tip acreage considerations in favor of soybeans.

"Farmers are routinely having to take out several million dollar loans, and given the current credit landscape, small [agricultural] lenders are having a tough time justifying this," given the uncertainty of their return, Maguire says. "Even professional ag analysts are having a hard time saying 'corn prices are going to be $5.88.' We have no idea. It's a moving target every single day."

Dohme adds that with the passage of the Troubled Asset Relief Program, the U.S. dollar will likely weaken, bolstering exports. Gold and other commodities, including the grains, would rally.

Lespinasse is optimistic about corn. "I am on the long side. It could work higher but it depends on the weather, the quarterly stocks report and the USDA crop report, so my bullishness is not rooted very deep," he says.


As the Untied States heads into harvest, traders will focus on Brazil and Argentina, which are entering planting season. Despite production increases, bean inventories also have remained low due to enormous demand, especially from Asia, where soybeans and meal are consumed as staples and to feed ever increasing numbers of hogs, which are eaten by China's growing middle class.

November '08 bean prices peaked in July at $16.31 per bushel, but have since traded down to between $11 and $12 per bushel in late September. Part of that decline can be attributed to a stronger U.S. dollar, which has been rallying since mid-July.

"In Brazil, the real was very strong against the U.S. dollar until two months ago, and that had a strange impact," Maguire says. Soybeans are sold in U.S. dollars, he explains, but all of the local costs are in the real. As a result, farmers were getting sharply lower selling prices given the exchange rate. That situation reversed in July, which likely will mean increased production. For the next several months Maguire says beans will trade between $11 to $12 per bushel.

Dohme expects U.S. soybean acres will decline by as much as one million acres, and for 2009 end stocks to be between 100 million to 120 million bushels. "We will pull away from our bean acreage and give it to South America and plant more corn."

Waldock says yields will be the key. "Ending stocks in the bean market are so tight that a one bushel swing in ending yields will either cut the ending stocks in half, or double them." Looking at the Commitment of Traders report, Waldock says large trader short covering, combined with renewed buying by small speculators, should fuel a rally to $12.15. Waldock expects 41 bushel per acre yields, and for soybeans to trade up to $13.75, forming the right shoulder of a much larger head-and-shoulder pattern. "The neckline comes in around $11.34 on a weekly chart. We could be in the process of forming a four to eight week right shoulder that would form a major top. If we get up to $14, it's definitely a sell. It's an opportunity to jump into a major cyclical top in the soybean market and I am willing to stick my neck out on that one."

With the Oct. 10 World Agricultural Supply and Demand Estimates report still on the horizon and the success of the Troubled Asset Relief Program an unknown, commodity markets are especially jumpy. "Trade with caution," Dohme says. "The volatility is so immense anymore it wipes everybody out in a matter of days."

Note: This feature length cover story by Chris McMahon originally appeared in the November 2008 issue of Futures Magazine.

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