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Commodity Futures Forecast

The S&P 500 rallied to a new all-time high as the Fed adopted a hands-off interest rate policy. With a slight easing in the Purchasing Managers' Index and signs that labor is not excessively tight (for now), investors gained the confidence to resume their buying frenzy. Is the economy perfect? Stock investors seem to think so!

The Fed's lack of action was widely expected and had little immediate impact upon the dollar and other currencies. For now, Europe and its currency traders are focused upon the potential breakdown in the unification process. With the United States offering higher and more stable returns, I would expect the Greenback to gain forward momentum, however, the index can't gather strength and the Fed's reluctance to nudge rates leaves the dollar neutral to bearish.

Some time ago, traders thought there was a correlation between interest rates and grains...particularly soybeans. There were also feelings that silver and beans carried a relationship. From a practical standpoint, interest rates can influence the cost of raising and storing a crop. In addition, interest rates impact the cost of buying and processing as well as exporting. In a less direct way, interest rates were affected by grain prices because government finances were influenced by farm support payments. Now, we are engaged in an experiment that phases out supports in favor of a free market system. This breaks the link between government spending and farm prices.

Thus, 1997 will be the first year that relieves the government from massive payments if grain prices collapse. It was fortuitous that 1996 left prices high as we moved into planting season. Farmers are better educated in hedging techniques and many were smart enough to lock in available profits a few months ago. This sharply contrasts with 1995/96 behavior where farmers and elevator operators were at odds because of poor marketing strategies and badly designed forward commitments. The point is that 1997/98 is truly a pivotal year that makes a transition from supports to a free market and from high prices to more average levels...for now. Timing couldn't be better for those who protected profit margins.

If all goes well, farmers will reap profits, the government will be saved from farm expenditures, and consumers will enjoy lower food prices moving into 1998. This hints at lower interest rates toward the third quarter rather than the predicted "nudge higher." This also suggests that the bull stock market isn't over. Assuming inflation appears under control, there won't be an incentive to raise rates. The only other factors are dollar strength and equity exuberance. Clearly, the Fed might conclude that stocks must be tempered and the dollar must be defended. Yet, we saw that picture before with Greenspan's market- related comments. I don't see why the brakes would be needed.

So far, weather across the major corn, wheat, and soybean belts has been excellent. Moisture has been reasonable, storm damage minimal, and yields are shaping up for records in many areas. Further, the late planting in some regions should be offset by crop switching. As previously mentioned, some farmers moved from cotton into beans. Other farmers moved marginal land into bean and corn production. Fields are planted fence-to-fence (or, road-to-road) and prices are still attractive on an historical basis.

The south central states are experiencing some dryness, however, a Canadian cold front is moving down to meet moist air in the U.S. midsection and some relief is predicted for the next 48 to 72 hours. Temperatures over the long weekend are going to be 10 to 20 degrees below normal from the northern border through the midsection. This leaves the grains in a bearish posture through this week. We are still a few weeks away from tasseling in corn and pod setting in beans. Therefore, weather is not as critical now as it will be towards the end of the month.

The enormous difference between old-crop inventories and new-crop prospects establishes the potential for a mid-summer rally. Inevitably, there are setbacks that can spike prices. A bullish consensus remains among traders who believe record crops are still deficient relative to predicted global stocks for 1998/1999. I have heard many advisors tell clients to buy calls in corn and soybeans in anticipation of a turn-around. I don't agree with the strategy at the moment because seasonal pressures can carry through the December deliveries.

I am inclined to favor the 1998 bull spreads in wheat and possibly soybeans. This may sound unusual when considering the amount of beans expected this fall. However, I agree with some bulls that a shortage may reappear by July '98. I don't expect the same profits we enjoyed this year in our July/November bean spread, but I would not be surprised to see a 30-cent potential.

After getting stopped out of our first short side attempt in cocoa, I moved into long puts to participate. Even if I had re-entered with short futures, I believe the stop would have been within range of last week's action. Hence, our conservative short by way of put options was appropriate. I believe the downward adjustment is just beginning. My original prediction was for a price near 1340 to 1370. This means there is still time to double up. The problem is exposure. Cocoa can be almost as bad as coffee! If there is reasonable liquidity toward today's early close, I may add to this. I was beginning to feel like cocoa was turning into another copper. Each time I looked for a copper top, the market rallied to our protection. The week I gave up was the turning point!

July 3, 1997Philip Gotthelf

Commodity Futures Forecast

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