Prepared by Richard A. Brock & Associates, Inc.
This past week we aggressively changed positions from being slightly bullish to being very bearish, particularly in wheat and corn and to a lessor extent in soybeans. While we did not want to make anyone spill their coffee in the coffee shop, for many reasons we felt that this past week was an extremely important timing week where decisions had to be made. As we've said time and time again, quoting Mark Twain–“If you have to swallow a frog, don't look at it very long.” This was a frog swallowing week!
To begin the week, the USDA released new supply/demand revisions for both domestic and world wide consumption. Not a lot changed–but everything was slightly to the negative side. Carry-over supplies of corn, feed grains, oilseeds and wheat all increased slightly. Carry-over supplies of coarse grains are now pegged at 102.85 mmt., which is up from the October estimate of 99.7, but still well under the 1996/97 carry-over of 119.16 million metric tons. This, however, compares to the 1995/96 bull market where carry-over supplies of world feed grains were only 95.44 mmt.
In the world soybean market, ending carry-over supplies are now pegged at 18.52 mmt.–up from October's estimate of 18.16. This compares to last year's 12.75 mmt. carry-over and the 1995/96 carry-over of 17.45 mmt. Needless to say, unless major weather problems occur in South America supplies of soybeans should be ample enough to prevent a major price squeeze to the upside.
Wheat is in a world of its own. Carry-over supplies are now expected to be 128.54 mmt. which compares to last year's carry-over of 108.79, a dramatic 18.2% increase. This compares to the 1995/96 carry-over of 105.4 mmt. Much of this is due to a sharp increase in carry-over supplies in the United States. Last year, when stated in millions of metric tons instead of bushels, the carry-over was 12.07 and this year it will be 17.83 million metric tons. No matter how you slice it, the world is not going to run out of wheat this year contrary to the hopes of many wheat producers.
This year the USDA is expecting carryover supplies to increase to 665 million bushels versus last year's 444 and the previous year of 376. Their estimate is that the wheat market will average between $3.40 to $3.70 per bushel this year. Compare that to December wheat futures trading at $3.60 this week. If asked the questions is the market high, low or about right–the answer is high. Compared to the expected average for the year and the fact that wheat prices have been above this for the majority of the year, the downside risk far out weighs the upside potential.
To add insult to injury, acreage will not likely drop much this coming year and with usage numbers leveling off, carryover supplies will likely increase next year to well above the 700 million bushel range. That means that new-crop wheat prices could well average in the low $3.00 range for the 1998/99 crop and with July futures this past week trading above $3.70, we concluded that the downside risk is large while the upside potential is very limited. To put it another way, it was decision making time.
Additionally, the technical trend is well confirmed as down. When December futures closed below $3.50 on Monday and July futures later in the week took out the support at $3.74, there was nothing bullish to hang onto from a technical point of view and at this stage everything lined up both technically and fundamentally for lower prices.
Strategically, that is why on Monday we recommended for anyone willing to buy back wheat to go to 100% sold on this year's wheat crop. Even if you are not willing to buy back, we recommend the minimum of being 80% sold. For hedgers we also recommended to lock in prices on 20% of new-crop wheat in the July futures at $3.75 on Wednesday. On Thursday we covered another 40% of the new crop by using an options strategy as outlined below. Specifically, we purchased July wheat $3.80 puts and sold $4.00 calls at a 14-cent differential. That in essence locked in a floor of $3.66 and put a ceiling on the crop at $3.86. Considering wheat was trading in the $3.70 range at the time, this is a very inexpensive way to establish a good floor and yet leave some potential to the upside.
We'd be the first to admit and agree to the fact that worldwide supplies of corn and feed grains are not abundant. However, that is also a very well known fact and is a major part of the reason for the sharp rally that occurred in prices in October. Until a week ago, we thought the odds were reasonably good that March corn futures could rally to $3.20 or possibly slightly higher. But that all fell apart on Monday when the USDA revised the supply/demand tables and the markets failed to move higher.
Specifically, carryover supplies are now expected to be 928 million bushels. Our estimate is 935. But more important, is the fact that with reasonable weather this coming Spring and an increase in planted acreage worldwide, the odds highly favor that within a year we're going to be looking at carryover supplies in excess of 1 billion bushels. Combine that with the fact that even based upon the USDA estimates that prices this year should average $2.45 to $2.85 and that when this report was released on Monday, March futures were trading above $2.90, it becomes obvious rather quickly that there is more risk on the downside than potential to the upside. Prices then broke through very key support areas and the rest of the week is history.
Technically, the major trend in both old and new-crop corn is now down. It will now be late spring or early summer before weather scares will be able to muster enough strength in this market to possibly get back to where prices are currently trading.
From a strategy prospective, we advised strict cash marketers to move from 40% to 50% sold and hedgers from 40% to 60%. On the new crop, we also recommended hedgers to establish short positions in December futures at $2.88 on 20% of anticipated new crop. By the time you read this, we may well have increased our coverage on both old and new-crop corn.
One of the difficult aspects of making marketing decisions right now, however, is that psychologically most people don't want to make any decisions right now. They just completed harvest, the bin doors have been closed and it's time to sit back and relax. Why worry about selling something that we just put in the bin? The answer–it's a good time.
No question about it. The soybean charts and fundamentals look different than corn. With an expected carryover supply in soybeans now of 255 million bushels, the USDA is expecting the average price to be $5.90 to $6.90 per bushel. But think about it! Futures are trading at near $7.40 in both January and March futures. Needless to say, this is also a market that has already discounted a large share of the bullish fundamentals.
For the past several weeks we anticipated that there was an outside chance that both January and March futures could rally to the $8.00 mark or possibly higher. There is still that opportunity–but it is rapidly diminishing.
From a technical point of view, it is of absolute importance that within the next five trading days nearby futures contracts close at new contract highs before closing under key support. The key support is $7.20 basis March futures. If the market does close below the support, the next downside target is $6.50.
November 14, 1997
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