Trading Grains on 2012 Drought

01/28/2014 7:00 am EST

Focus: COMMODITIES

For those who remember the horrible drought in the Midwest in 2012, Chris Lehner of Archer Financial Services explains why the current low grain prices will most likely persist for the foreseeable future.

I came up with the title because it is similar to what I hear time and time again. "What if there is a drought?" This is a question thrown back to me when I ask both hedgers and speculators, "What have you sold for old crop and new crop corn, soybeans and wheat?" For some reason, both speculators and hedgers remember the drought of 2012 and the rally in grains because of it, but seem to forget the good weather and price reversal of 2013. Personally, I would like to forget the drought, horrible high temperatures, and the devastation on crops.

But, what I find most unusual when looking back several decades, droughts that rally prices are an anomaly and occur rarely. Years when prices fall are common events.

It is time to face the facts that grain prices have fallen well off the 2012 highs and with what we now know, they will continue to fall. Of course, you may want to come up with a new rumor of the day, or like the supermarket tabloids believe, crop circles are the precursor of alien landings coming to take grain, but facing the facts and using the facts is the far better approach to trading.

I don't like sounding like a parrot repeating the same thing over and over, but for the past couple of weeks as I have said many times, the trading in corn and soybeans, and it is very evident, has been predominately large speculators liquidating long older positions and now outright selling soybeans and buying corn to step out of spreads. There is still very little hedge and selling pressure from US producers who continue to store all grains and use their grain bins as their method of risk management. The reality: storing grain that isn't hedged or contracted is close to the opposite to risk management as it can be.

For months, from late winter of 2013 throughout the summer and fall of 2013, the Commitment of Traders showed large speculators were buying beans and selling corn. It was obvious they were doing it as a spread when the weekly trade commitments often showed changes in the ratio of two soybeans to five short corn.

Now with China announcing that they succeeded in building a two-year reserve for soybeans and cotton since they began the self-sufficiency reserve program in 2008 and knowing Brazil is growing the largest crop of soybeans ever produced, how will bullish traders maintain their outlook? Now China is moving to farmer and user subsidy programs. The demand to source soybeans outside of China will substantially decrease and buying will become a decision more about buying on a price schedule versus buying large quantities to fill reserves.

It is also evident now that large speculative formula programs and speculative traders are slowly but surely backing out of their profitable long soybeans and short corn spreads. They are also starting to bear spread soybeans similar to how corn has traded for months and months.

On January 15, the March to July soybean spread closed with March trading over July by 36 cents. As I write, on Jan 23, the spread has narrowed by 10 cents. Bear spreading is as the name implies, bearish. Merchandisers are encouraging sellers to keep beans and corn from being sold at the present to sell it in months to come. It is perfectly obvious why they are doing it. With US farmers holding old crop and with a record-breaking supply being produced in Brazil, merchandisers need to keep from being flooded over and are paying producers to sell into the future. It is the simplest function of grain trading when there is a surplus crop.

NEXT PAGE: Why Are Traders Holding Onto 2012?

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Why Are Traders Holding Onto 2012?
It was a horrific year for many US farmers in 2012. Actually, it was pretty hard on anyone living in the United States, especially from the upper Midwest, northern Plains, to the Southwestern states. Day after day, July temperatures often soared above 100 degrees Fahrenheit, and if there was a cloud in the sky, it sure wasn't a rain cloud. Anyone who ventured outside from the city to the farm saw what it was doing to the lawns and gardens and in rural areas field after field were so dried up it was comparable to the 1930s Dust Bowl.

But with all the devastating heat and lack of rain what was truly amazing when combines moved across corn and soybean fields beginning late August 2012, US farmers found that a crop was produced and it was sufficient in size that it lasted until the harvest of the 2013 record-breaking corn crop took over. The crops of 2012 also fulfilled needs of a world market as top corn buyers from Japan, Mexico, and China filled shipments interested more about quantity than price paid. For farmers around the world, strong demand and low supplies pushed prices to the historically highest levels ever paid. It was also a good year for speculators who generally prefer to be long than short, especially smaller speculators. Farmers also benefited with US government insurance payments plus additional payments from the US farm program.

The drought could have been a disaster but ended up for many US farmers a very profitable year. For those contracting 2013 and 2014, it likely will end up being the best three years in a row. So there is no question why there is a desire for a drought. It ended up being financially good for those producers that took advantage of government crop insurance programs.

But like most high price years, the old adage "high prices kill high prices" has run true to form and from the times combines started harvesting in 2012, throughout 2013 and 2014, prices for corn and wheat have tumbled and soybeans have slowly but surely and more as of late, fallen and appear to be maintaining the downward trend started 16 to 17 months ago.

I reviewed 2012 because it appears it cannot be forgotten. Even as memories fade of what the extremes in heat felt like when outside and as the 2013 crops surpassed record yields in US corn production and soybean production in Brazil, the prices attained in 2012 are being held onto like a new mother to a day old baby. The feeling is as strong now for many farmers and traders that new highs will return and they seem to forget how the record crop yields of 2013 are pushing prices lower and lower.

It is time to let go of 2012 and to use the commodity markets for the reason they began back in 1847. They are called futures markets. Not past markets. Bear spreading is negative to price action.

In 2008, the agricultural ministry in China announced they were building a two-year reserve program. Each year since the announcement of the reserve program they have told the world of their intentions. Now that the program has met the requirements, it is time to forget the drought reduced supply, pushed higher by quantity buying and remember, large supplies push prices lower, especially when buying diminishes.

It is time to put the past well behind you and use commodity futures for their intended purpose; to trade and protect the future.

By Chris Lehner of Archer Financial Services

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