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It’s harvest season, and with a bumper crop of corn expected this year, we intuitively assume grain prices will drop. But the market’s a bit more complicated than that, and despite short-term weakness there are plenty of reasons to go long grains.
And that could mean you should go long oil, too.
Here’s what I mean…
Wheat, corn and soybean prices climbed -- 28.5%, 31.75% and 40%, respectively -- from October 11, 2006 through June 19, 2007. Prices for each of these three crops were near their all-time highs for the year.
Currently, their prices are up 87%, 10.75% and 51.75% on the year. But interestingly, since late September, prices have been falling in tandem, with wheat dropping 7.67%, corn falling 12.89%, and soybeans falling 8.45%.
What are the factors behind these price moves?
Wheat prices skyrocketed, and have continued to rise, ever since a severe drought knocked out a significant portion of Australia’s wheat crop. Australia is a major exporter of wheat.
Corn prices rose in response to increased ethanol demand when refiners switched over from MTBE to ethanol for blending to meet EPA standards.
Soybean prices have climbed due in part to rising demand in the alternative fuels and foods sector, but also because farmers were dedicating more fields to corn.
Soybean prices have climbed due, in part, to rising demand in the alternative fuels and foods sector, but also because farmers were dedicating more fields to corn.
In understanding these dynamics, it becomes clearer why prices are beginning to retrace.
We’re expecting a major corn crop this year. Perhaps larger than any we’ve seen before. That extra supply will have bearish effect on corn prices. The same goes for wheat. Australia’s receiving more normal precipitation, and with more wheat in the ground, larger supplies could further dampen hot, high prices.
That means over the short term, grains prices should continue to fall.
But that’s just over the short term. The long-term picture is a different story. World demand for grains is growing, particularly as China begins to consume a more complex diet (moving from rice to corn). And to top it off, the declining dollar is also playing a large roll in the commodities bull market.
I think it’s one of the main reasons why oil is still trading over $80 a barrel, but we’ll get to that in a minute.
A recent Barron’s article noted, “It was no coincidence that the great commodities bull market of the ’70s followed the effective devaluation of the dollar by ending the greenback’s convertibility into gold at $35 an ounce in August 1971. … An ever-declining dollar will be a boon to American farmers who will be able to sell their high-priced crops (in greenbacks) competitively into a buoyant world market.”
If you’re going to play just grains on their own, I think soybeans are your best bet. They haven’t risen quite as high as wheat prices have, so this mini price collapse shouldn’t take as much out of soybean prices as it will wheat. But they’ve still performed well, especially compared to corn prices.
Corn demand from the ethanol industry, and a possible increase in demand from China, should provide incentive for farmers to continue to plant corn over soybeans, which will provide ample support for higher soybean prices.
But you’re not just limited to playing grains right now. Oil’s still a great long-term bet, and its rise is also tied to that falling dollar.
Last year, oil prices started dropping rapidly in late summer when it became apparent that we wouldn’t have a bad hurricane season. The housing market, though bad, was not as big a threat to our economy as everyone now thinks.
Now, U.S. Dollar Index futures are sitting about 5.64% lower than at the beginning of this year.
Here’s where things get a bit more complicated, and I’m not going to pretend it all makes sense right now.
In the same time that the Dollar Index futures fell 5.64%, Dow futures have climbed 11.16%, S&P futures have climbed 7.97%, and Nasdaq futures have risen 20.25%. In other words, the markets showed a strong economy despite a falling dollar value.
Strong economies have strong demand for oil, and as oil is denominated in U.S. dollars, oil prices have been augmented by both sides of the story. Even more so when the Fed cut rates by 50 basis points…
Personally, I think there are some fierce supply-and-demand dynamics affecting the price of oil right along side the other economic factors that will have long-term implications.
That’s why I remain a long-term oil bull. I also think that in the short term, oil prices will drop. In fact, I think they need to drop in order to move higher, and give world economies a chance to get used to prices above $80.
Additionally, a move back below $80, even down to $75 or so, would shake out some of the speculators that have glommed on to this latest price rise.
So, futures players, the advice is the same for both oil and grains: Short-term bears take advantage of a drop that will continue over the next two months, perhaps three. Long-term bulls take advantage of that dip as we head into the new year.
If you want to get fancy, try a spread and profit from both moves.
S.R. Nunnally
Editor, Commodities & Resources Report
Taipan Financial News
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