ECON 338C: Topics in Grain Marketing

Econ 338C, Spring 2009

ECON 338C:Topics in Grain Marketing

Chad HartAssistant Professor/Grain Markets Specialist

[email protected]


Today’s Topic

Price Projections and Issues

with an update on the World Ag. Supply

& Demand Estimates report

Econ 338C, Spring 2009 Source: USDA, WASDE report, April 2009





July 2010 Corn Futures

3.50

4.00

4.50

5.00

5.50

6.00

6.50

7.00

7.50

3/2

1/2

00

7

5/2

1/2

00

7

7/2

1/2

00

7

9/2

1/2

00

7

11

/21

/20

07

1/2

1/2

00

8

3/2

1/2

00

8

5/2

1/2

00

8

7/2

1/2

00

8

9/2

1/2

00

8

11

/21

/20

08

1/2

1/2

00

9

3/2

1/2

00

9

$ p

er

bu

she

l

Source: CBOT


Likely Range

2

3

4

5

6

7

8

3/2

1/2

00

7

6/2

1/2

00

7

9/2

1/2

00

7

12

/21

/20

07

3/2

1/2

00

8

6/2

1/2

00

8

9/2

1/2

00

8

12

/21

/20

08

3/2

1/2

00

9

6/2

1/2

00

9

9/2

1/2

00

9

12

/21

/20

09

3/2

1/2

01

0

6/2

1/2

01

0

$ p

er

bu

she

l

Example: CBOT July 2010 Corn Futures


Likely RangeBased on current futures and the option premiums for options on those futures

They determine an implied volatility, a measure of the expected variability of the futures price from the current point on

If you take Econ 437, you’ll learn about the mathematical models used to derive the implied volatility

Given the volatility, we can outline the likely range


Pricing Paths

2

3

4

5

6

7

8

3/2

1/2

00

7

6/2

1/2

00

7

9/2

1/2

00

7

12

/21

/20

07

3/2

1/2

00

8

6/2

1/2

00

8

9/2

1/2

00

8

12

/21

/20

08

3/2

1/2

00

9

6/2

1/2

00

9

9/2

1/2

00

9

12

/21

/20

09

3/2

1/2

01

0

6/2

1/2

01

0

$ p

er

bu

she

l



Prices Could Be Higher

2

3

4

5

6

7

8

3/2

1/2

00

7

6/2

1/2

00

7

9/2

1/2

00

7

12

/21

/20

07

3/2

1/2

00

8

6/2

1/2

00

8

9/2

1/2

00

8

12

/21

/20

08

3/2

1/2

00

9

6/2

1/2

00

9

9/2

1/2

00

9

12

/21

/20

09

3/2

1/2

01

0

6/2

1/2

01

0

$ p

er

bu

she

l



… Or Lower

2

3

4

5

6

7

8

3/2

1/2

00

7

6/2

1/2

00

7

9/2

1/2

00

7

12

/21

/20

07

3/2

1/2

00

8

6/2

1/2

00

8

9/2

1/2

00

8

12

/21

/20

08

3/2

1/2

00

9

6/2

1/2

00

9

9/2

1/2

00

9

12

/21

/20

09

3/2

1/2

01

0

6/2

1/2

01

0

$ p

er

bu

she

l



Market SituationReviewing recent past and the current

situation in the marketUsing historical relationships to link

changes in key variables to changes in commodity prices

Evaluating if current relationships differ from historical patterns


Market OutlookInterpreting market factors that impact

prices and shape marketing and management decisions

Analyzing how the changing supply and demand factors will impact price

Basing outlook on economic principles, statistical analysis, and market knowledge


Market OutlookOutlook depends on timing

Immediate: within a day or a weekShort term: few weeks to few monthsLong term: next growing season to multiple

years

Different information needed for each type


Immediate Term Outlook

4.30

4.40

4.50

4.60

4.70

4.80

4.90$

pe

r b

ush

el


Market timingAny scheduled market movers (USDA reports, etc.)


Short Term Outlook

3.50

4.00

4.50

5.00

5.50

6.00$

pe

r b

ush

el


Prices are adjusting to balance demand with available supplies

One reason to need short term outlook: Storage decisions


Long Term Outlook

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

7.00

3/3

0/2

00

9

4/3

0/2

00

9

5/3

0/2

00

9

6/3

0/2

00

9

7/3

0/2

00

9

8/3

0/2

00

9

9/3

0/2

00

9

10

/30

/20

09

11

/30

/20

09

12

/30

/20

09

1/3

0/2

01

0

2/2

8/2

01

0

3/3

0/2

01

0

4/3

0/2

01

0

5/3

0/2

01

0

6/3

0/2

01

0

$ p

er

bu

she

l


Buyers and sellers have time to adjust to changes in prices and quantities.

Important for investment decisions and government policy setting


Sources of Outlook InformationPrivate sector market analysis firms

For-profit companies that sell servicesOften more short-term focusedMay be associated with a trading company

In-house analysisOutlook for the company with own staffADM, Cargill, etc.But your local elevator may offer analysis as

well


Sources of Outlook Information Land grant universities

Long termExample: Food and Agricultural Policy Research Institute

(FAPRI) Intermediate to short term

Examples: Iowa Farm Outlook (Grain, Livestock, Dairy), Farmdoc.com, Livestock Market Information Center

Often affiliated with university extension services

Commodity organizationsTypically narrowly focused on commodityMay miss breath of outlook


Sources of Outlook InformationUSDA Data and Analysis Sources

National Agricultural Statistical Service (NASS)Production, consumption, and survey statistics

Agricultural Marketing Service (AMS)Summaries of local market prices

Economic Research Service (ERS)Analysis of agricultural markets and government

policies

Foreign Agricultural Service (FAS)Trade information and analysis


Examples of Outlook Information World Agricultural Supply and Demand

Estimates report http://www.usda.gov/oce/commodity/wasde/latest.pdf

Iowa Farm Outlook http://www.econ.iastate.edu/outreach/agriculture/periodicals/ifo/

FAPRI Outlook http://www.fapri.missouri.edu/outreach/publications/2009/FAPRI

_MU_Report_01_09.pdf http://www.fapri.iastate.edu/brfbk09/BrfBk2009.pdf


U.S. Corn Supply and Use

Source: USDA, WASDE and NASS

2007 2008 2009

Area Planted (mil. acres) 93.5 86.0 85.0

Yield (bu./acre) 150.7 153.9

Production (mil. bu.) 13,038 12,101

Beg. Stocks (mil. bu.) 1,304 1,624

Imports (mil. bu.) 20 15

Total Supply (mil. bu.) 14,362 13,740

Feed & Residual (mil. bu.) 5,938 5,350

Ethanol (mil. bu.) 3,026 3,700

Food, Seed, & Other (mil. bu.) 1,337 1,290

Exports (mil. bu.) 2,436 1,700

Total Use (mil. bu.) 12,737 12,040

Ending Stocks (mil. bu.) 1,624 1,700

Season-Average Price ($/bu.) 4.20 4.20


Iowa Farm OutlookMonthly outlook from ISU Extension

Other universities offer similar services


FAPRI Reports

U.S. Corn Utilization

World Soybean Production

Source: FAPRI, 2009


Evaluating Source of InformationKnow the source of data and analysis

Understand the motivation of the sourcePublic institutionPrivate analysis, for salePrivate analysis, confidential

What are the resources and track record


Outlook IssuesEfficient market hypothesis

All available information is quickly factored into the markets and embedded in the price

New information and/or changes in supply and demand after the outlook alter outcomes

Participants react to forecasts


Seasonal PatternsA price pattern that repeats itself with some

degree of accuracy year after year.Supplies and demandOften sound reasonsWidely knownLinked to storage cost or basis patterns in

grainsLinked to conception and gestation in livestock


Seasonal Pricing Patterns

0.94

0.96

0.98

1.00

1.02

1.04

1.06

Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec

Corn Soy

Source: USDA, NASS,Monthly Price Data 1980-2008


Charting

Channel lines


Sell Signal

Sell signal

A sell signal is one close below the charting lines


Buy Signal

Buy signal

Some chartists need only one close above the charting line to create a buy signal, others use two closes above.


Key Reversal

A key reversal is when the daily high and low price range exceed the price range for the previous two days.


Gaps

Gaps often occur when a major new piece of information hits the market. They are often filled in by later price movements.


Double Tops & Bottoms

Double tops and bottoms show prices with major technical resistance. These can be several days apart.


Head & Shoulders

Source: Figure 7, Charting Commodity FuturesAg Decision Maker, File A2-20


Moving Averages9 day average18 day average40 day averageSell signal

Buy signals


Relative Strength IndexLooks at last X days worth of closing prices

X = 9, 14, 30, etc.Summarizes upward and downward price movements during the period

Record the last 14 days worth of price changes, based on closing pricesSum the positive and negative price changes and create average for eachRelative Strength Index = (Up average/(Up average + Down average))*100


Relative Strength Index

Date Prices Price Change Up Down3/16/2009 4.44753/17/2009 4.4425 -0.005 0 0.0053/18/2009 4.4225 -0.02 0 0.023/19/2009 4.51 0.0875 0.0875 03/20/2009 4.5075 -0.0025 0 0.00253/23/2009 4.5 -0.0075 0 0.00753/24/2009 4.4825 -0.0175 0 0.01753/25/2009 4.4125 -0.07 0 0.073/26/2009 4.47 0.0575 0.0575 03/27/2009 4.445 -0.025 0 0.0253/30/2009 4.43 -0.015 0 0.0153/31/2009 4.6075 0.1775 0.1775 04/1/2009 4.52 -0.0875 0 0.08754/2/2009 4.585 0.065 0.065 04/3/2009 4.6 0.015 0.015 0

Averages 0.02875 0.017857

RSI 62

RSI for July 2010 Corn


Relative Strength Index

RSI’s above 70 (80) are considered signals of a market due to declineRSI’s below 30 (20) are considered signals of a market due to rally


Does Technical Analysis Work?

Arguments for it:Real world markets are not perfectly rationalMarkets may be slow to respond to new informationTechnical analysis works with the psychological biasesIt works because so many people use it

Self-fulfilling

Arguments against:Efficient market hypothesis

The current price holds all of the relevant information


Convergence IssuesTypically, as futures contracts reach maturity, futures price and cash prices at delivery points tend to converge to the same level.

For several grain and oilseed futures contracts over the last few years, this has not occurred.

“Poor Convergence Performance of CBOT Corn, Soybean and Wheat Futures Contracts: Causes and Solutions”Scott Irwin, Philip Garcia, Darrel Good, and Eugene KundaUniversity of Illinois, March 2009


Corn (Lack of) Convergence

Source: Irwin, Garcia, Good, and Kunda, 2009Marketing and Outlook Research Report 2009-02


Soybean (Lack of) Convergence



Wheat (Lack of) Convergence



Why Is Convergence An Issue?

1.Non-convergence indicates the market is out-of-balance.“When a contract is out of balance the disadvantaged side

ceases trading and the contract disappears.” (Hieronymus, 1977)

2.Non-convergence adds to the uncertainty in basis and limits hedging effectiveness.



Factors The relationship between the spread between

futures contracts and the cost of carry (think storage costs) In the settlement process for corn and soybean futures,

the delivery instrument is a shipping certificate. If it is advantageous to the holder of a shipping

certificate, they can delay delivery and effectively store the grain, paying CBOT set storage costs.

Structural issues related to the delivery process Does the general trade flow of the commodity line up

with the possible delivery points under the futures contract?



Spread vs. CarryLook at the ratio of the futures spread versus the cost of carry

Futures PriceNext – Futures PriceNearby

Storage Costs + Interest

Irwin, et al. found lack of convergence when ratio is high (> 80%)

A lower ratio implies smaller returns to holding a shipping certificate and more offsetting positions are taken, lowering futures prices.

If the commodity is still in storage, then cash sales aren’t happening, lowering cash prices.



Delivery Points


Corn Soybeans Wheat

How much of the commodity is moving through the delivery point areas?


Convergence vs. Carry - Corn



Convergence vs. Carry - Soy



Possible Reasons for High Ratios1. CBOT storage rates below commercial storage rates

2. Large “long-only” index funds rolling to the next contract at the same time

3. Large risk premiums built into futures to cover uncertainty

Irwin, et al. found support for #1 and arguments for #3, but did not find support for #2.



Possible Remedies1. Increase CBOT storage rates

Done for corn and soybeans in late 2008

2. Change delivery points to include more of the commodity shipping area Mostly an issue for wheat

Other proposals: Move to cash settlement Force delivery Limit the number of certificates that can be held



Relative Basis Change - Corn


The closer this is to one, the more effective hedging is.


Relative Basis Change - Soy


The closer this is to one, the more effective hedging is.


Class web site:http://www.econ.iastate.edu/classes/econ338C/Hart/

See you next week!

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ECON 338C: Topics in Grain Marketing