Grains: Déjà vu All Over Again
05/06/2013 7:00 am EST
Based on data in the CFTC’s latest Commitment of Traders report, there is a possibility for a significant rally this summer, if weather conditions are not perfect, writes Andy Waldock of Commodity & Derivative Advisors.
The grain markets are beginning to look like 2010 all over again. The corn, bean, and wheat markets all had substantial rallies, with each setting all-time highs in 2008. The markets then formed a secondary peak in 2009 before drifting lower to sideways through the early summer of 2010, which ended up being the base for the all-time highs. The most consistent reason for expecting a similar outcome this year is based on the same external factors in play this year like ending stocks and global demand. However, these factors have already been accounted for. The hidden key to these expectations lies in the market actions of the commercial traders.
The Commodity Futures Trading Commission (CFTC) publishes a weekly report of the each market’s main participants and their actions within the markets they trade. These groups include small speculators, like ourselves, who hope to profit from our actions in the market, as well as commodity trading advisors (CTAs) who manage pools of money and are professional traders. The CFTC also tracks the actions of hedgers, people who genuinely use the futures markets for their intended purpose of mitigating risk throughout the crop cycle. A new category added over the last few years has been that of index traders. Index traders manage money based on an exchange-traded fund like CORN, obviously an ETF based on corn. Index traders simply track the movement of the underlying asset in their fund. Their actions are seen as adding volatility and speed to the market. They buy on the way up to match the index to the underlying as it climbs and sell on the way down to match the market as it falls.
The final group of traders tracked in the primary report is the commercial traders. This is the group of traders that either produces or consumes the underlying market. In the case of corn, this would include Fortune 500 companies like Monsanto (MON), Archer Daniels Midland (ADM), and ConAgra (CAG) on the production side and Pillsbury (GIS), McDonalds (MCD), and Kellogg’s (K) as end line consumers. We follow this group because of the market research facilities that they employ. They have access to the best models and end line estimates of where they believe the market should be valued. Therefore, when a market becomes significantly over or undervalued they can take advantage of the difference between where the market is trading compared to where they think it should be trading.
This brings us to our current situation. All three primary grain markets provided clues to the coming rallies based on the surge of accumulation by end line users during the post planting lulls. Fear in the grain markets comes in three phases and each carries with it a built-in premium followed by a sell-off if the fears are unfounded. The first concern is planting fear. Provided the crops get in the ground on schedule, the market will gradually decline with a sigh of relief. The second is summer drought. Enough said, there. Finally, weather concerns around harvest. Again, followed by a post harvest decline and sigh of relief.
The commercial traders’ net position has grown substantially throughout this spring. In fact, their purchases viewed in the aggregate of the three markets is only eclipsed by their buying in 2010. This tells us two things. First of all, we are starting the season at prices that are generally viewed as undervalued by the end line consumers. Secondly, that there is significantly more fear of a future shortage than surplus. Based on the commercial traders’ predictive capabilities, we believe that there is the possibility for a significant rally this summer, if weather conditions are not perfect.
By Andy Waldock, Founder, Commodity & Derivative Advisors