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| First, I chose not to spend my day in a darkened room; I am limited to one glass of juice & after a couple glasses of water, it was back to the coffee pot & the markets.
Recognizing there may be some confusion about my last few postings. First, as an elderly person I ramble and since I am confused most of the time, I often forget to be explicit.
I remain friendly to old crop soybeans, wheat and new crop grains. But, expect wild swings in the old crop soybeans and wheat. Carrying charges in old crop wheat have virtually disappeared; soybeans still have a carrying charge. Since neither old crop wheat nor old crop beans have truly inverted, the potential yet remains for higher prices.
New crop soybeans and new crop wheat, when the blow off occurs will have made their major top. Currently, we are in a very complex market. Demand driven old crop markets and concerns about supply (acreage) supply-driven new crop markets.
The grain complex, in terms of price expectations and analysis should be viewed as to which are demand driven markets & which are supply driven. There is a difference. Demand driven markets usually eventually invert. Demand-driven markets are very difficult to trade. At what price will folks around the world choose to reduce the consumption of bread and other wheat products? No one knows.
Same for soybeans. A myriad of products are produced from soybeans. It is not simply the aggregate demand for meal, even though meal is showing leadership at the moment. What price will begin to shut off demand? No one knows. The additional complication in soybeans, while export sales have been aggressive, actual shipments have not maintained the same aggressive pace.
Prior to ethanol, feed grains, mostly corn, were simpler to evaluate. An elastic price relationship to demand and supply. Feed grains were worth whatever was the potential profitability of the production of livestock.
Ethanol makes corn more inelastic in price response. Ethanol, currently limited by logistics and distribution will become even more inelastic as those problems are addressed. Ethanol, while a burgeoning industry, is very young in terms of measuring the effect of supply and demand; it is yet an unknown.
The primary questions: at what price level will new crop acreage be bought? At what price level will old crop demand be rationed. Which will occur first? Last week I began to anticipate a blow off in old crop markets but as real demand unfolds in early 2008, the bull could again grab these old crop markets. Not necessarily so for new crop. If actual shipments of US old crop soybeans do not materialize and are shifted to SA, the game is over, unless additional supply concerns develop in SA. A huge risk. However, a risk I am willing to assume.
The point is, the old crop markets are high risk trades for speculators. Demand driven markets are subject to wild price swings. In 1973 & 1974, the bull had to be willing to ride $1.50 to $2.50 price corrections. Once out, it was difficult to find a spot to re-enter.
1973 & 1974 were demand markets due to the largest grain transactions in history. However, in some respects the true price discovery was not determined. Demand was influenced by the embargo of soybean sales to Japan. So, in my view, the true value of soybeans was not determined. The same with wheat and corn in 1975 & the Ford embargo on sales of grain to the USSR.
Price discovery in Drought markets, 1988, for example, are generally supply driven. In supply driven markets carrying charges generally exist and when the distant month reaches the ration point, a price top is achieved. Much easier to trade.
Supply driven markets, once a blow-off is experienced…is over…prices are down hill thereafter until some other concern arises or prices reach levels sufficiently low and long enough to ‘buy back’ demand.
In a general sense, these current old crop markets are in a less constrained environment.
From another view, on the other side of the coin in measuring value, in 1973, the major grain companies owned most of the export fobbing capacity (facilities to load vessels): Cargill, Continental, Illinois Grain, Producers, Farmers, and a few public grain elevators. ‘Out of position exporters’ did not own fobbing capacity. They traded either CIF rail or barge while selling FOB. The elevation cost was generally 1 to 2 cents, the spread between CIF and FOB. In that period, WS, the head of research for a smaller grain company, advised his employer, to lease fobbing capacity; a very shrewd tactic. The demand for export grain exceeded our ability to load the vessels! The price of elevation (fobbing capacity) advanced from 2 cents per bushel to nearly $2.00 per bushel placing the ‘out of position’ export players in a difficult situation (called insolvency). This was priced into the value of the soybeans, so how do you measure that influence?
When Exportklub, the USSR buying arm came to the USA, their negotiations were top secret. The export business is secretive. It was not until a variety of export sales had been completed the industry realized the markets had been ‘scooped.’ A great deal of this business had not been hedged & when the exporters raced to hedge (buyers) in an already strong market, prices exploded.
As example, when the members of Exportklub were entertained by one grain company, on a trip to Niagara Falls, out of the clear blue they requested quotes on a large quantity of soybeans. The conditions of the transaction were to be secret. Two of the grain company decision makers excused themselves to have a conference in the motel bathroom; “how do we price this? Our soybean ownership is low? The ocean freight was known, but for one or two cargoes, not 10 or 15 outfitted for Black Sea destinations. What was that going to cost? Should we add 50 cents? $1 per bushel? $1.50?” These were the days of back to back & forward grain trades of ½ cent margins & hoping to make some $$$ on carrying charges and the basis. In one sense, the world changed that night.
While markets have periods of imperfections, markets do have a sense of the unknown. In the early seventies bull, the initial influences were sales of CCC corn and an unusually early and vicious snow storm in the eastern Corn Belt. Soybeans were not fully harvested. Prices persisted strong even though few people knew the USSR had suffered a crop failure of great magnitude; the Kremlin did not know immediately. My younger brother, now at rest in Arlington, then associated in the military with a very secretive government organization much later told me he noticed failing crops on the satellite photos. So did a few other young fellows from Kansas, Oklahoma & etc who were also on the team. However, the bureaucrats were not about to send a security assessment to the White House based on their farm boy opinions. By the time PhD agronomists passed security clearances, the game was almost over. The story I heard, one of the last people in the information chain to know the real circumstances in the USSR was President Nixon.
The additional point in today’s old crop markets, who is yet to come to the table? Has someone made sales which are not yet covered? Is someone stuck? Those are unknowns, big ones. In terms of price discovery, on that night at Niagara Falls the price of soybeans increased by nearly $2 per bushel above the prevailing market, but had yet to unfold in the market place.
We are at price levels for new crop which are very attractive to producers, the demand for the paper is there and sales should be made accordingly. Certainly costs will be higher next year, production costs seldom decline; land values are higher requiring greater margins to provide an increased ROE. When this new crop market tops, there will be a foot race to sell. Selling into strength is best in my view. Few will ever sell near the exact top.
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Points of Clarification
