Wet Weather & Trade Threats has Ag Market Fundamentals Changing Rapidly

Rarely have we seen a month where the function of a market has changed so dramatically, writes Chad Burlet.

Rarely have we seen a month where the function of a market has changed so dramatically. For the first two weeks of the month the function of the futures market was to discourage the planting of unneeded acres. U.S.-China trade negotiations were at a stalemate and, according to the May 10 World Agricultural Supply and Demand Estimates (WASDE), we were on track for burdensome U.S. and world carryouts. However, on the morning of May 13, there was a growing awareness that U.S. corn planting was not going well. Early planting had been slow due to cool temperatures and wet soil, weekend rains had been heavier than expected, and the one- and two-week forecasts had turned decidedly wetter.

As futures prices turned higher the record corn shorts started to cover. Then, on May 23, the U.S. Department of Agriculture and the White House announced the second Market Facilitation Program, MFP 2.0. The program provided financial support to U.S. farmers who were being harmed by the U.S.-China trade war. An important feature of the program was that farmers had to plant to receive their payment. Many quickly realized that this would add back acres, which otherwise might have gone unplanted. That $14 billion government program could have completely changed the direction of the market, but CME Group corn futures saw only a brief 12¢ correction. By the end of the next day prices were making new highs for the crop year. Fueled by the dual engines of record short covering and a dramatic change in the fundamentals, futures rallied 95¢ in just over two weeks.

Unfortunately, the weather and planting conditions have continued to worsen. Many key producing states have had record spring rains and the pattern is not forecast to change. This year’s corn planting is the slowest on record. As of last Sunday night there were a record 99 million corn and soybean acres yet to be planted. Many farmers who have never been part of the “Prevent Plant” program will be forced to participate this year.

The pace of change in U.S. corn production estimates has been breathtaking. Many respected analysts have cut their estimates by as much as a billion bushels in a week. On May 10 the USDA estimated this year’s U.S. crop at slightly more than 15 billion bushels. Now, due to a combination of lost acres and lower yields, a crop as small as 12.5 billion bushels is possible. Losses of that magnitude are sufficient to make a meaningful change not only in the U.S. but also on the world’s balance sheet. That 2.5 billion bushels is 63.5 million metric tons (MMT) or exactly 20% of the world carryout. It would take us from a near record carryout to a six-year low. Ironically, the USDA chose this year to also start reporting “World Carryout Less China.” They estimated that number at 123 MMT. So, in less than a month, we may be cutting the world’s “free” carryout by more than one half.

By the end of next week we will have narrowed the potential range of planted acres considerably and yield will loom as our largest variable. We are already seeing strong evidence of slow emergence, low populations and poor stands. We should expect pessimistic yield estimates and low condition ratings for at least the month of June.

Soybeans

The soybean market has been a reluctant price follower of the corn market, moving at only 1:1 to corn prices since its own May 13 low. Three factors have combined to move the ratio of July soybean and corn futures from 2.3:1 to 2.0:1.

First, soybeans have a planting window that is 15-30 days later than corn in most areas. Farmers who were unable to plant corn might switch to soybeans.

Second, African Swine Fever (ASF) has dramatically reduced the demand for protein in general and soybean meal in particular. Initial estimates for 2018-19 China soybean imports were 100 MMT, but their current pace projects toward a total of only 83 MMT.

Third, within that reduced world trade of soybeans the United States is being hurt the most. The U.S.-China trade talks have broken down, the rhetoric has turned more negative, and relations between the two countries are at a multi-year low. China currently has 7 MMT of unshipped purchases of U.S. soybeans. Market participants fear that many of those may never be shipped. U.S. cash prices have moved to a significant discount to South America and that price incentive has so far motivated China to continue shipping from the U.S., but that could change.

Wheat

Wheat futures prices have done a good job of keeping pace with corn prices. The price spread between the two is exactly where it was on the morning of May 13. Wheat has also been fueled by major short covering and at times led the corn rally by more than 20¢ per bushel.

At the beginning of May the Kansas Wheat Quality Tour found excellent conditions and projected a very large Hard Red Winter wheat crop. Unfortunately, all U.S. winter wheat has reached the point in the production cycle where rains go from being beneficial to being detrimental. The same rains that are preventing corn planting are hurting the winter wheat crop. There are also a few areas where spring wheat planting has been delayed.

Overseas, it’s dry in portions of Australia but the crops in Europe and Asia are generally good with only a few dry spots on the watch list. The fundamentals of the world wheat market don’t appear to be in line for the type of supply shock that the corn market is experiencing. Also, while the quality of the U.S. wheat crop is being hurt the quantity is not being reduced in a significant way. As such, we expect wheat to lag corn on any further rallies.

As we end the month the EPA has announced approval of year around E15. This was widely expected and will not make a significant change in the amount of corn used for ethanol. Also in Washington, President Trump announced a 5% tariff on Mexico as a penalty for what he sees as an insufficient effort to curb illegal immigration. With imports projected at 18.5 MMT Mexico is by far the world’s single largest importer of corn and our #1 customer.

Brazil was already making inroads into this market, and worsening trade relations with the United States will only hasten that change. The threat of these tariffs is the primary reason corn is lower today. Tariffs notwithstanding, we still expect corn to remain the price leader due to poor yield prospects. The market will need to carry a sizable risk premium for a considerable period of time. We also recognize that soybeans have become cheap relative to corn and that they are about to enter their own time crunch to get all of their acres planted. However, the record soybean carryout and declining export demand do afford this market a bit more of a cushion.

Third Street Ag Investments, LLC is a Commodity Trading Advisor (CTA) that offers the Fundamental Discretionary Ag managed futures trading program operated by Chad Burlet and Bob Otter.