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Old Crop Supply Issues Don't Yield To Weather Concerns

Memorial Day marks the start of summer. But even though a fourth straight growing season kicked off with unusual weather, the grain market still seems more focused on the effects of last year's drought on dwindling old crop supplies of corn and soybeans.

Inventories of both key commodities are expected to be very tight when the 2012 marketing year officially comes to an end on Aug. 31. The slow start to the growing season means those stocks must be stretched even longer before results from the 2013 harvest are available. Imports will supplement remaining domestic supplies, but getting those shipments where they're needed won't be an easy task.

July corn and soybean futures both rallied in May, despite talk of imports on their way from South America. One reason for the move higher was uncertain flow of crops across the equator. Both Argentina and Brazil suffer from labor problems with dock workers and at times farmers, who know they're in a strong bargaining position to press long-standing demands.

Though weather in the U.S. has been anything but reliable the last few years, U.S. agriculture learned the hard way about stiffing customers, after the infamous Russian grain embargo of 1980. Our competition's inability to deliver on-time, without a lot of drama, has not only caused buyers to start booking new crop corn and soybeans aggressively. It's also forced some back to the U.S. to compete with domestic end users here for what little old crop remains.

To be sure, U.S. livestock herds are smaller than before the drought. And some ethanol plants and soybean crushers closed due to lack of supplies to process. But the businesses that are open are making money. It's the market's job to put them into the red, either with higher prices for raw ingredients – corn and soybeans – or by raising the cost of their products – ethanol and distillers grains, or soybean oil and meal -- more than buyers are willing to pay.

Ethanol production in mid-May jumped to its highest level since the drought took hold 11 months ago. Demand is good: Ethanol stocks fell to the lowest point since November 2010, pushing prices to a narrow discount to gasoline. Margins are beginning to show signs of pulling back, which could lead more plants to shut until harvest supplies are available.

Margins also were supported by the price of distillers' grain, thanks in part to tight supplies of soybean meal, which continues to trade above $400 a ton. Only values of soybean oil, which peaked in 2011, are lackluster. Nearby futures crush margins have dropped dramatically for July contracts, but August and September remain good, suggesting the old crop story isn't over yet.

Still, the market is showing signs of stress. July soybean futures rose above the trading range that held them in check since November, blowing almost all the way up to a target from mid-September at $15.4725. That marked a rally of more than $2 off April lows.

July corn's gains were more modest. The contract faltered after moving into a gap on the chart created by the bearish March 28 USDA grain stocks report at $6.76, which was close to several other technical flashpoints.

Look for the fate of these July contracts to dominate the discussion in early June. Though it may be summer, it's probably still too early for growing season weather to trump tight old crop supplies.

Corn prices are trying to avoid a seasonal slump into early June, but despite recent gains, both old and new crop futures are hardly raging bulls. July and December futures remain in downtrends off last year's highs, keeping the May rally a rebound correction for now. July futures needs a move over $6.85 to turn around its trend, while the bar for December is around $5.60, close to the base price used in Revenue Protection crop insurance contracts.

Important answers for both contracts could be answered by key reports out June 28. USDA provides updates on planted acreage and grain stocks. While growers made record strides planting corn in mid-May, wet forecasts for the northern Corn Belt could mean some ground doesn't get in, especially with crop insurance prevented planting dates starting to pass.

The stocks data could be crucial to figuring how much corn will be left by the time new crop arrives. While exports and ethanol production data are reported weekly, the third leg on the demand stool, livestock feeding, must be implied by changes in quarterly grain stocks. These updates have produced extremely chaotic reactions the last few years – prices crashed after the government's March numbers were almost 400 million bushels more than the trade expected.

While history favors rallies during the growing season due to tight old crop stocks, producers should take nothing for granted in a year that could see $4 corn, or $8 corn, or perhaps both. At a minimum have bushels above the crop insurance guarantee protected as close to the base price as possible. For more downside protection on inventory that will be stored, consider paying for a short-dated December put that expires in late August by selling a deep out of the money July 2014 call. The call incurs margin and fixes a maximum price, but the put guards against a drop in prices through the August USDA report.

Soybean prices are providing a lot of entertainment value thanks to wild swings in old crop prices. But few growers have a lot of inventory left and should focus instead on how to guard against a downturn in new crop bids.

November futures is showing signs of building a move towards the Revenue Protection base price of $12.87. Growers should make sure to have bushels above the RP guarantee covered by then, adding more if they can't make a profit if the market heads lower into 2014.

If farmers don't plant more acres than March intentions, the market will be more sensitive to weather later in the growing season, when South American farmers will also need incentives to plant their next crop. But an increase in acres here, coupled with above average yields should make $12 a memory.

Good U.S. yields also likely would sink basis, as the world market will still be swamped with the last of the South American crop. But cash basis should improve, making storage with hedges worthwhile, because Chinese demand should recover if their economy improves as expected.

Wheat prices continue to be a soap opera. Just as the market appeared ready to break to harvest lows, prices firmed on better exports and rallies in corn and soybeans. But the path of least resistance may still be lower for wheat.

There are plenty of sources of concern because no growing region is benefiting from perfect weather this spring. It's been too cold and wet in parts of Western Europe, and too hot and too dry in parts of the Black Sea. The U.S. hard red winter wheat crop remains under stress as early harvest gets underway in southern Texas, and some fields on the northern Plains may be too wet for spring wheat to be planted, too. In the Southern Hemisphere eastern Australia finally got rain for planting, but production there also looks likely to be less than a bumper crop.

Nonetheless, without a widespread disaster, rallying wheat will be tough in a market where some of the biggest customers are strapped for cash. With both yields and quality still uncertain for U.S. growers – the PNW has its own issues – growers should stick to the options market once bushels above their crop insurance guarantee are priced. The Chicago July $7 put only provides only a month of protection, but that may be enough to determine which way this market is headed.