As the commodity markets enter the second quarter of 2017, they appear to be facing a global recovery but perhaps not as brisk as was hoped for in in the weeks and months following the US election. While the reflation prospect remains in play, the potential for a commodity rally has been reduced by the prospect of numerous US interest rate hikes. On the other hand, the global economy has not seen this type of widespread, geographically diverse forward motion since 2013-2014. To rekindle the post-election optimism quickly, it will require action on US tax reform and infrastructure spending. Unfortunately, the new administration has been mired in typical Washington wrangling which has resulted in pro-growth policy initiatives being shunted to a back burner. But, prospects are still good for some form of tax reform and some measure of infrastructure spending, which should result in a return to reflation-type action in stocks and commodities.
From an international perspective, there has been widespread confirmation of slow and persistent economic recovery, but again the pace has failed to live up to initial expectations. Commodity traders are justified in their close scrutiny of China, as its impact on commodity demand shouldn’t be underestimated. While the Chinese economy is attempting to shift to a domestic, demand-driven system, it is still heavily reliant on manufacturing exports. Evidence of recovery across the globe should provide an economic boost to China directly ahead. The Chinese economy continues to be a mirror-image of its major trading partners, and stronger international growth/increased economic activity should effectively pull the Chinese economy forward.
Another indication of improving commodity conditions comes from the energy sector, where daily news headlines are flush with reports of first-time-ever shipments of energy products to locations that have never been part of the global trade. Oil and natural gas shipments from the US to Asia, Eastern Europe and even Russia are being seen, which should begin the process of moving some of the world’s excess oil supply out of the US. A look at monthly US export levels for petroleum and natural gas shows that a major trend may already have begun. We would suggest that the natural gas market is a perfect case study. It has been one of the most oversupplied commodities of the past eight years, and increasing international demand for this cleaner-burning fuel appears to have started the process of balancing excess supply.
With China and India both suffering from dire air pollution, the need to shift from coal-fired to natural gas-fired electricity generation presents a whole new factor in the world energy equation. Some economists consider energy demand to be one of the best measures of the global economy, which suggests that oil prices will continue to be a leading indicator for other commodity prices. Many signs point to stronger growth around the world, and that in turn should pump-up demand for a wide range of industrial commodities as well.
With the key March 31st USDA Grain Stocks and Prospective Planting Reports out of the way, the focus of attention for the grain markets will shift to the new crop season. Before this happens, the markets may need to price-in the results of the reports. Corn is quickly adjusting to a smaller acreage base, and traders are already watching the weather patterns for the planting conditions in the Delta and the southern Midwest. The soybean market is in the process of adjusting to a lower price level due to record planted area and higher than expected March 1st stocks. Wheat prices tried to decline in the wake of the report because of ample short-term supply, but the small acreage base in the US and elsewhere leaves the market in a position to build some weather premium.
In the wake of the USDA Prospective Plantings and Grain Stocks reports, December Corn jumped as much as 13 ¼ cents in just a few sessions. The plantings report was considered bullish, with March 1st planting intentions coming in at 90.0 million acres, nearly 1 million acres below trade expectations. It was also down more than 4 million acres from last year. With soybeans pulling acreage away from corn and the southern Midwest and Delta regions getting hit with wet weather, the trade could soon question whether this plantings number will be achievable.
The market seems to have already priced in a very large South American crop, ample US supply and record-high world ending stocks for the 2016/17 season. If it looks like world ending stocks for the 2017/18 season could decline, December Corn will likely build a weather premium for the planting or early-summer growing seasons. The short-term, old crop supply is burdensome, but this has already been factored into prices. If it looks like world and/or US ending stocks will be smaller for the 2017/18 season, the corn market will be in position to move to a higher price level.
The USDA March 1st Grain Stocks report was considered bearish at 8.616 billion bushels, as it was 82 million bushels above trade expectations. This should increase the ending stocks estimate for the 2016/17 season by about 40 million bushels and add to the beginning stocks estimate for the new crop season.
Using the smaller planted area from the plantings report and a trend yield of 170.7 bushels per acre would project ending stocks to decline to 2.134 billion bushels in 2017/18, down from 2.32 billion this season (see table below).
If yield slips a mere 5% below trend to 162.2 bushels per acre (which would still be the fifth highest on record), ending stocks could slide to 1.429 billion bushels and result in a stocks/usage ratio of just 9.9%. In the last 43 years, the stocks/usage ratio has been under 10% only six times. The market might have rallied even more in the wake of the USDA reports if it were not for the bearish news for soybeans.
US ethanol exports are up significantly due to movement to Brazil, but Brazil is threatening an import tax. Increased ethanol blending in the US could boost demand as well, which would be positive for corn prices and not expected. In addition, China’s planted area might drop significantly for the new crop season, which would help them eat through their massive government storage stocks more quickly. We should point out that one of the main reasons for the recent cheap corn prices has been the expectation for a surge in corn production in South America for 2016/17. And while the jump in production has kept prices lower, a shift back to soybeans, especially in Argentina for the new crop season, could mean smaller supply next year.
The corn market is deeply oversold basis traditional technical indicators and the recent Commitments of Traders update, which indicated that non-commercial traders were net sellers of 81,783 contracts for the week ending March 28th. They had been net long the previous week, but they had switched to a net short 43,927 contracts as of the report date. Trend-following fund traders (non-commercial, no CIT) increased their net short position by a whopping 71,727 contracts in just one week to -149,285 contracts. These heavy net short speculative positions leave the market vulnerable to increased buying if resistance levels are violated.
Suggested Trading Strategies
- BUY December Corn at $3.81 ½ with an objective of $4.13 ½. Risk the trade to a close under $3.75.
- BUY a September Corn $4.20 call at 11 cents with an objective of 29 cents. Risk 6 cents from entry.
With very bearish crop yield reports coming out of Brazil, very weak basis levels reported in the US and a sharp drop in Chinese soybean futures to their lowest levels since October, the fundamental news flow continues to be a strong bearish force. July Soybeans fell as much as $1.45 from the January peak to the April 4th low. The USDA grain stocks report on March 31st was considered bearish versus trade estimates, as March 1st soybean stocks came in at 1.734 billion bushels versus an average estimate of 1.684 billion bushels. The 50 million-bushel difference could show up as higher old crop ending stocks. The stocks estimate was already up 203 million bushels from last year prior to this report.
The USDA Prospective Plantings Report was also bearish, as planting intentions came in at a record-high 89.5 million acres versus the average estimate of 88.3 million acres. Even though the market has already declined as much as $1.00 per bushel in the wake of the report, we would expect rallies to be hard to come by unless there is a weather issue during the planting or growing seasons.
Looking ahead to the upcoming crop year (see table below)
- If we assume beginning stocks will be up to 460 million bushels and we use a trend yield of 48.0 bushels/acre (down 7.9% from a year ago), ending stocks could come in at a record-high 665 million bushels.
- If yield is down 5% from trend, ending stocks could come in at 452 million bushels.
- If yield is 5% above the trend (50.4 bushels per acre, still down 3.2% from last year), ending stocks could come in at whopping 878 million bushels. This would result in a stocks/usage ratio of 21.5%, up from 10.6% for 2016/17 and 5% for 2015/16. This would mark a 32-year high for stocks/usage and would be the second highest on record.
- If yield were to come in the same as last year, ending stocks could reach 1.029 billion bushels. (The previous record high was 574 million bushels from the 2006/07 season.)
- If US ending stocks do reach 665 million bushels, it would mean that US alone could add 6.3 million tonnes to the world ending stocks total.
The USDA has estimated Brazil production for the current harvest at 108 million tonnes, but there are many commercial firms who expect further adjustments higher. There have been several estimates of around 111 million tonnes, and one prominent Brazil firm put production at 113.8 million.
World ending stocks for the 2016/17 season are already projected at a record-high 82.82 million tonnes. On top of record US plantings for the new crop season, China is expected to shift more of its planted area towards soybeans and away from corn. Argentina is expected to rotate back to soybeans for the coming year, which could also boost production.
The soybean market is deeply oversold, and as of April 4th July Soybeans had closed lower for the fifth straight session and for nine of the previous ten days. The RSI has fallen to 8.4%, and the market could have a relief rally for no apparent reason. There is also the potential for the meeting between President Trump and Chinese President Xi to offer fresh inputs for the market to digest.
The Commitments of Traders reports as of March 28th showed trend-following fund traders holding a net long position of 10,256 contracts, down 22,884 contracts in just one week. In light of the selling since that report date, the funds are probably net short by now.
Suggested Trading Strategies
- SELL July Soybeans at $9.92 ¼ with an objective of $8.82. Risk the trade to $10.17.
- BUY a July Soybean $9.40 put at 10 ¼ cents with an objective of 59 cents. Risk 7 cents from entry.
- SELL 2 December Corn $3.40 puts and BUY 1 November Soybean $8.60 put for even money on the spread. Use an objective of +59 cents on the spread, and risk a total of 12 cents on the entire position.
The higher close in Chicago Wheat on March 31st after the market had traded in a 15 ¼-cent range for the day helped confirm a short-term low. The trade focus may shift to northern spring wheat plantings soon.
A spike in heat in India last week has some traders concerned that their wheat production might not reach recent expectations calling for a record crop of 96.64 million tonnes for 2017/18. The USDA grain stocks report was considered slightly bearish against trade expectations, as March 1st wheat stocks came in at 1.655 billion bushels versus an average estimate of 1.627 billion bushels. The Prospective Plantings Report was considered neutral, as all wheat planted area came in at 46.059 million acres versus the average estimate of 46.1 million acres.
Overall, the report news was considered bearish, but with the market already pricing in bearish news, new selling ran dry on the move to new lows. Wheat acres are at 109-year lows, and cash wheat basis levels are already hovering just above loan levels.
With very good rain events in late March and early April, winter wheat crop conditions should improve dramatically. Kansas is expected to receive more rain in the next few days. Weekly crop conditions as of April 2nd, the first report of the season, showed 51% of the winter wheat crop in good/excellent condition. This was down from the 58% in November 2016 (prior to dormancy) and down from 59% a year ago at this time. Crop conditions now are very similar to the 2015 crop year, which yielded 43.7 bushels per acre.
The supply/demand table below shows some “what ifs” for the 2017/18 season. The scenarios include one with a trend yield of 47.1 bushels per acre, one with a yield 5% below trend (44.7 bushels per acre), and one with 5% above trend (49.5 bushels per acre). With the three yields, the wheat balance sheet could see ending stocks decline from 1.129 billion in 2016/17 to 822 million, 916 million or 1.009 billion bushels for 2017/18.
If conditions are wet in North Dakota in the month ahead, the potential for difficulty getting the spring wheat crop in the ground on time could be a supportive force. Traders will also be monitoring weather in the Central Plains. The takeaway point here is that there are plenty of weather uncertainties to be traded over the next two months for wheat.
With wheat prices currently at very depressed levels and the recent Commitments of Traders report indicating that trend-following speculators ware net short 157,615 contracts (close to the record -164,690 contracts), the downside looks limited. If weather suddenly turns worse or a late spring freeze occurs, the wheat market could see a significant rally. March 31st saw an outside day higher close, with the RSI and slow stochastics all turning up from oversold levels. The market is in search of a catalyst for the next move, and the recent drier pattern in Europe and Russia could be it. With world and US ending stocks burdensome this year after near-perfect weather for key exporters last year, a crop problem in the US, Europe or the Black Sea region could confirm a major low is in place. Markets tend to bottom when supply peaks.
Suggested Trading Strategy
- BUY a July Wheat $4.50/$5.00 bull call spread at net cost of 8 ¾ cents. Use an objective of 22 cents on the spread, and risk 4 ¾ cents on the trade.