When there is blood in the street that may be the time for the best opportunities. That is much easier to quote than it is to take action when it is your blood in the street. Yesterday was beyond words painful. As with any disaster, there are multiple contributing factors that all happen at the wrong time. In my opinion, comments by the Federal Reserve, cooler and wetter forecasts, and rumors of changes to the biofuel policies of the Biden administration were the main factors that caused the crash yesterday. Once the market hit technical levels and encountered margin call selling it snowballed.
Federal Reserve Announcement
Up until this week, the Fed has been insisting that all the price increases we have seen are only temporary supply chain issues and not inflation. They have been saying they are going to continue supporting the US economy with no interest and bond purchases and do not see a rate increase until at least 2024. This week they acknowledged inflation risk and said to expect a rate hike (or two) by the end of 2023. They did not say that they were going to begin slowing bond buying, but hinted that may be announced at the August meeting.
So why did the commodity markets react like this? Think about it as driving a giant ship, the US economy. The ship can only turn very slowly so the Fed cannot make any sudden moves. Every word they say is closely analyzed to try to glean what they are going to do many moves out, not just right now. Right now, the Fed is continuously pumping liquidity into the economy and trying to keep everything going. Money is cheap, plentiful and looking for returns. Everyone knows inflation is coming and the Fed will have to slow this stimulus down at some point. They have to slow the stimulus down slow enough to not crash the economy, but all this spec money reacts quickly. No one wants to be the last spec money left in the commodities. That is why something they talked about doing three years from now caused so much money flow right now. Spec money was getting out. All the commodities that have been the strongest like lumber, copper, bitcoin, corn, soybeans, soy oil have taken big hits in the last week. Yesterday, enough was sold in the grain markets to hit some spec longs with some big margin calls and they decided to get out too. That is how the snowball gets bigger and bigger.
The two main models followed by the trade are the Euro and the GFS. The GFS model has shown building significant precip totals for the parched areas of the Western corn belt and Iowa. Euro has been much more reserved with the forecast accumulation. Neither of these models have very strong confidence right now (also illustrated by how far apart they are from each other). The drought areas are growing. There is no subsoil moisture in reserve so most of the Midwest needs timely rains for the entire summer, not just right now. We have a long growing season, one or even a couple rain events are not going to make this crop. We need a near record crop to add anything back to the balance sheet.
This one is still all rumor at this stage as nothing has been confirmed officially, but seeing how much the price of RINS (credits for blending ethanol) dropped this has had some effect on prices. The renewable fuel standard says that a certain amount of ethanol has to be used in US gasoline (and biodiesel in diesel). The previous administration tried to get around that mandate for the benefit of the oil companies using a loophole. They were sued and the courts closed the loophole they were trying to use. The new administration said they were not going to appeal the ruling and were going to support the biofuel industry. The rumors this week were that they were going to try to find some workaround to provide some relief to the oil industry. There is no consensus on exactly what that looks like right now but the market is nervous about it.
Where Do We Go From Here?
We knew it was going to be volatile but still shocked on a day like yesterday. Even with the good fundamentals we have, it may take a little while to get that back. We need some help from the weather. We are still at a fork. If someone knew exactly what the weather looked like for the rest of the summer, they would know where this market is going. I feel better going into the acreage report on June 30th at these levels because these price levels should have some bigger acres already priced in. If we burn the crop up this summer, we are going to go to levels we have never seen before. If the weather turns wet and cool for the rest of the summer, the highs may be behind us. We still have a long growing season ahead.
Yields and quality have been extremely mixed. I have seen some areas of exceptional quality and some with marginal. There has been more freeze damage shown by the combine than we saw while scouting. With all the wheat that has been sucked up in the feed channel, milling wheat bids are going to go to rail replacement very quickly. There are still triple digit bids at flour mills for harvest in NC which is very rare. If you have bushels over your feed contract that you do not want to store for fall, work on getting basis on them now. There will be a push to move wheat at some point, it just may not last long. If you know you need to move a little in July, I recommend shopping sooner rather than later. Be patient on basis for wheat going in the bin for fall/winter delivery.
Cotton had held on much better than the other commodities until yesterday. Yesterday cotton took a big hit which oddly gave me a little bit of comfort. It helped support the hypothesis that this was driven by the outside markets rather than a change in fundamentals. Bullish macro data is good for cotton. The acreage report on June 30th should be good for cotton. I still think we can see 90 cent on cotton. Be patient.