TREND WATCH
Prepared by Scott W. Barrie
Grains
(January 2001) The changing of the year has a pronounced effect on the marketing of commodities. As the calendar year changes, so does the tax year for many producers. This encourages producers to hold off "marketing" (or selling) their recently harvested crops into this tax year, as they can incur the expense of production in the ending year and postpone the revenues of marketing into the next tax year.
This tax related selling is commonly referred to as the "February Break" and weighs on a plethora of markets, from corn and soybeans to wheat. Adding to the bearish effects of tax related selling at the beginning of the year is the distribution network for grains.
Most farmers sell their grains to elevators, who store the grains and market them throughout the year. Because the elevators are located in the Midwest near the grain producers, they have difficulty marketing grains until spring since most inland waterways, like the Saint Lawrence Seaway, are iced over during the winter. This tends to create a glut of supply in the central United States and a scarcity on the coasts, where most of the population resides. This supply glut near the production centers tends to suppress prices in the early part of the new year.
This situation should drive grain prices lower in January and February, and create some bargain prices in the spring for grain traders. This month we examine the grain trade and help you to plan your grain operations in the coming months.
Cotton
Though cotton can be effected by the "February Break" like other annually produced crops, cotton tends to break early in the month and rally hard.
Cotton is the fabric of choice for spring and summer clothes. Hence, in preparation for summer fashions, mill demand for cotton often explodes at the beginning of the year. The same transportation problems which weigh on grain prices can create a scarcity of cotton for fabrication, and lead to increasing prices in the spring.
Inside this edition of Trend Watch, we examine the cotton market and its potential for a rally.
Cotton trades in a fashion very similar to the grain markets. Being a field crop, cotton's production is effected by the same weather and production considerations.
It is not uncommon to see cotton prices plummet at the beginning of the year, as producers dump supply on the market. However, the "February Break" tends to mild for cotton because of the nature of the demand for cotton.
The bulk of the cotton produced in the world is spun into fabric, used by the textile mills to make our clothes. Cotton, due to its light weight, strength, and "breathable" nature, is the preferred fabric of choice for spring and summer fashions. This tends to see demand for cotton sky rocket in February and March as mills work overtime to meet the growing demand for cotton from the fashion industry.
This increase in demand, coupled with potential shortcomings in supply can be seen by the fact that May cotton futures have increased 12 out of the last 15 years from the end of January (01/26/01) until mid March (03/14/01).
Currently, May cotton futures are entrenched in a down trend. This is somewhat typical, as cotton prices tend to break from mid September through December. Historically, cotton prices tend to meander around at the beginning of January, before rallying strongly in February and March.
Cotton rallied from a low in July '00 of 59.25 to an eventual high at the end of November of 70.50. During December, cotton broke through the 50% retracement level of 64.87, and looks poised to test the 67% retracement level of 63.00.
Chart support is evident at the August lows of 62.50 and at the consolidation area of 60.00 to 61.00 made in April. The July low of 59.25 should also act as major support. Against this technical backdrop, we expect the cotton market to bottom out between 59.25 and 63.00 during the month of January.
Based on the above, we are recommending the purchase of May cotton on January 26th, if May cotton stays above 59.25 until January 26th. Though a stop loss does not guarantee to limit risk to a specified amount, traders should risk 4.00 cents (-$2,000 before commissions and fees), moving the stop loss to the entry price if a +2.00 cent ($1,000 before commissions and fees) profit is achieved, and continue to hold the position until March 14th.
Financials
The election is finally over, but the effects of the election on the financial markets is far from over.
Historically, the first year of a new Presidency has seen the Dow Industrial Average put in sub-standard returns (Harding +12.7%, Eisenhower -3.8%, Nixon -15.2%, and Reagan -9.2%).
Typically the interest rate markets have declined (higher rates) at the beginning of the year as well. With the rate market already "factoring in" a rate decline, traders may wish to watch the Eurodollar market for a potential top. With a potential Fed easing, and a weaning U.S. currency, Japan may be able to raise rates in 2001 (watch Euroyen).
A Glimpse At The Grain Markets...January Through The "February Break"
Probably the best known of all the seasonal tendencies in the futures market is the "February Break." Attributed to tax deferred marketings in the New Year, as well as supply gluts due to transportation problems, the "February Break" is a feature every grain trader should be aware of.
The "February Break" tends to begin in January. Typically, CBOT wheat is the first market to turn down, followed by soybeans and then by corn. The grain markets tend to top out in the second week of January, often plummeting until the last week of February.
According to the 2001 Grain Trader's Almanac, May soybean futures have declined in 12 out of the last 19 years during the month of January, losing a total of -87-1/2 cents during the month. In February, May soybeans have lost a total of -111 cents, declining 11 of the last 19 years. Though wheat has tended to rally in January, the "February Break" is most felt in this market. May wheat futures have declined 13 of the last 19 years, losing a total of -137-1/2 cents in February.
Trader's should pay particular attention to the Annual Crop Production report released at 5:30 AM on January 11th. This report has often moved the markets, as the USDA frequently uses this report as a vehicle to radically change previous production or usage figures. Also released on the 11th is the Quarterly Grain Stocks report. This report details how much grain is in storage, and whether the grain is held by producers (On-Farm) or by elevators (Off-Farm). Typically the larger amount of grain held "On-Farm" the larger the "February Break" because producers have yet to market their production.
From mid January until the end of February, it is not a typical top see grain prices come crashing. In over half of the last 19 years, grain futures have posted lower lows in January as opposed to December. This trend is continued in February as well.
Against this backdrop, we are expecting May corn futures to test the 220 support area in the coming weeks. May soybeans, after penetrating minor support at 510, may test major support in the 476 to 482 area. May CBOT wheat may break through support in the 274 to 276 area during the throes of the "February Break."
However, things are typically darkest before the dawn. Next month, CFEA will highlight the spring rally and the potential for a tremendous rally in the grain markets.
USDA Report Highlights
January Annual Crop Production (January 11th) is the final report detailing 2000/01 crop year. The most accurate of the Crop Production reports, this will give the marketplace its definitive look at last year's production, and a very accurate look at how much grain was consumed and is let going into the 2001/02. This report has often seen extreme volatility associated with it, as it is potentially extremely market moving.
Annual Grain Stocks Report (January 11th) details how much grain is being held and by whom. Supplies--or stocks--are broken down into "On-Farm" and "Off-Farm" supplies. This report details the current supply situation, how it is held, and how much grain was consumed in the final quarter of last year.
Annual Winter Wheat Seedings (January 11th), the seeded acres for winter wheat, durim and rye is detailed in this report. This report is the most accurate look to date at the amount of wheat planted in the 2000/01 crop year.
Prospective Planting Report (March 30th ), this report, which is derived from scores of USDA/NASS interviews with producers serves as the base for the planted acerage in the May and June monthly Crop Production report.
Crop Progress Report (Weekly starting April 2nd), each Monday during the growing season, the USDA/NASS releases the progress and condition of the crop from Planting to Harvest.
The "Fabled February Break"...Possible Wheat Weakness Ahead
Chicago Board of Trade wheat is classified as winter wheat, meaning it is planted in fall and harvested in the summer. During winter the wheat crop is dormant, waiting under a protective layer of snow to emerge in the spring. During the dormant stage of development, the wheat crop has little risk of damage. However, stress during this stage can manifest itself later in the spring, when things green up.
Winter wheat tends to be the hardest hit of the grains during the "February Break." This may be due to the fact that wheat is more of an international market, with almost half of the U.S. production exported. Thus transportation difficulties tend to affect wheat more, as supply buildups in the central United States weigh more on prices. In support of this is the fact that in the last 19 years, May CBOT wheat futures have only rallied 3 times during the month of February!
Against this fundamental and historical backdrop, the current CBOT wheat technical picture is very interesting. May wheat has been in a narrowing trading range for the last two months bounded by the September low of 274 and the October high of 305-3/4. Year-end strength in winter wheat has this market in the upper half of the trading range as we enter 2001.
Based on the above, we are recommending the sale of May wheat at or above 292-1/2 during January. Though a stop loss does not guarantee to limit a loss to a specified amount, we recommend risking the trade to 312-1/2 with a downside objective of 270 by the end of February. If 282-1/2 is violated to the downside, use a 10-cent trailing stop loss holding until the end of February.
The "Fabled February Break" And Beyond
The grain markets operate on an annual production cycle so supply must be rationed or spread out over the rest of the year. The market mechanism for rationing supply is price. When prices are high, consumers are discouraged from consumption to some degree and the supply will last longer. When prices are low, consumers are encouraged to use the product to a certain extent and the supply is used up.
But price also acts as a stimulus for supply. When prices are high, producers are encouraged to increase production to increase profits. However, when prices are low, producers tend to decrease production since profit margins are not as great. This type of market behavior sets up a paradox, in which low prices discourage production, and high prices encourage production, but producer reactions to prices cannot occur until the following year. As such, swings in annually produced commodities, especially when supplies are currently tight, tend to be exaggerated when the crop is vulnerable to damage.
The current situation in the grain markets is one of low pricing. Prices are historically low, stimulating record grain usage and producers are facing planting decisions. Trade estimates for winter wheat, which was planted in September and October, show a dramatic decrease in acres planted as a result of low prices. In January and February, corn and soybean producers will make planting decisions and given the current supply glut and low prices, less acreage planted looks to be the order of the day.
Corn Nearest Contract Monthly Performance
Source--2001 Grain Trader's Almanac.
As detailed else where in this newsletter, we are expecting prices to go lower, which may be setting up a historic buying opportunity in the grain markets this spring and summer. The charts detail total monthly performance based on total cents gained (lost) during the last 19 years. As can be clearly seen in these graphics, grain markets have tended to be the strongest during the planting months (March and April for corn and soybeans) and the emergence months of spring when winter wheat greens up.
Soybeans Nearest Contract Monthly Performance
Source--2001 Grain Trader's Almanac.
Keeping this historical performance in mind, traders should start watching the grain markets extremely closely. The current situation of historically large usage due to low prices coupled with potentially lower production, due to poor profitability in grain producing may be setting up this segment of the market for a major rally starting in the spring.
Wheat Nearest Contract Monthly Performance
Source--2001 Grain Trader's Almanac.