I hope everyone had a great Thanksgiving and those that did not look at the market last Friday may have had a little better weekend. Just about every market we follow, and most that we don’t, fell victim to significant selling. Midweek this week markets found support and started gaining back their losses. There was a lot that happened to cause this huge pullback but I will boil it down to what I see as the most important drivers.
The thing that was in most of the headlines was the new covid variant, Omicron. I understand the massive selloff of all asset classes in the first few waves because we did not know what to expect. Now after so many waves I was a bit surprised at the magnitude of the market reaction especially to a variant that seems to be mundane (as far as outcomes) compared to earlier ones even if it does spread more easily. I think the reaction was not to the variant itself, but fear about what the world governments were going to do in response. At this point in the pandemic now that we have much more data, it seems that broad lockdowns are very ineffective at slowing the spread but that still does not stop some governments from enacting them anyway. So I think the variant itself was only a small part of the selloff and fear of government reactions was another small part no matter how much they were hyped in headlines.
Another big factor contributing to weakness, especially in corn, was weakness in energies. Crude oil hit highs at the end of October of almost $84/barrel. The US has publicly asked OPEC to increase production to try to stem the increase and has also announced a release of oil from our strategic reserves coordinated with other countries doing the same to try to lower prices. The fear is that oil prices going too high too fast will itself slow the recovering world economy. The release of the strategic reserves will do little in the long term. High prices will do more good as it will incentivize US production to come back quicker. OPEC had planned to start increasing production but there were some questions that with the strategic reserve releases and the concerns of lockdowns due to the new variant they may not go ahead with the increases. Yesterday they announced they would continue with the planned increases which should have been even more bearish to crude but it has come back from its low of 62.43 and traded as high as 69.22. The market going higher after bearish news is a hopeful sign of a low. With crude prices, ethanol producers are making margins that were unimaginable not that long ago. Corn has been trading like an energy and will continue to do so. Weakness in crude will translate to weakness in corn. Crude should have support here and so should corn.
The US federal reserve this week has finally started saying something that everyone else has been saying for months. Part of the inflation we are seeing is not just transitory and will not just disappear when supply chain bottlenecks get worked out. Some of the inflation we are seeing is going to be with us for a long time. The Fed is confirming they are going to slow bond purchases which is the first step toward raising interest rates to try to slow inflation. Unfortunately economies in the rest of the world are not recovering as fast as we are so they will not be able to start easing liquidity all together like they wanted. It is going to be a very difficult balancing act to try to battle inflation while not acting too fast and upsetting the recovery. On the Fed announcement, equities took huge hits as money pulled out of stocks. In my opinion at this point in the recovery anytime money is coming out of stocks it is going to be looking for an inflation hedge and commodities fit that bill.
Fed policies to save the economy have led to unprecedented liquidity in the economy. We have had increasing amounts of institutional money trading in the commodity space for as long as we have had futures markets. That trend has increased through this crisis as there is now massive amounts of money in and out of the grains. This serves to amplify volatility and can increase the magnitude of rallies and corrections. If you believe in efficient markets, the market will always get to the “true” fundamental value but sometimes it takes a wild ride to get there. Over the last week we have the December futures contracts go into delivery so all the money that was in the nearby contract had to roll. Several commodity analysts have hypothesized that we had seen a lot of money just get out of nearby positions and wait a while to get back in the deferred months. This would realize a lot of profits for their year end bonus. Money will continue to push these markets and add to volatility.
The last factor I will cover is most of the time the one we say is the most important: the fundamentals. Corn in addition to being supported by energy prices has also been supported by wheat’s dramatic climb. Wheat rallied sharply early last week due to excessive rains in Australia which will damage quality and then collapsed a few sessions later after Australia’s Department of Ag report estimated record yields. As our crop reports, that was backward looking and did not take into account weather that is happening right now. There were other countries that also released increased production estimates including Canada and Argentina that added to pressure. Tensions between Russia and Weakness in wheat spilled over into corn. South America continues to have a great looking crop and corn planting in Argentina is off to a good start. There are some dry areas developing in what may be the beginning of the La Nina cycle that we have been talking about for a year now, but it is not enough to threaten the crop yet. That is something that will determine the market going forward.
Corn and soybeans have now put good support in. We should stay in this range for a while until we get something else to trade on. Resistance in corn is going to come in near $6 on the board. In order to break through that level, we need dry weather in South America, more Chinese demand or higher energy prices. Support should hold above $5.50 unless we get continued perfect weather in South America and start raising crop size estimates, energy prices start selling off below their support or we get more panic across the board. We had a big crop in the US but it has been put away for the most part now and farmers are well capitalized. I would be a seller approaching $6 but not a panic seller on breaks in the market. I would not be selling new crop yet.
Soybeans have a wider range with resistance at $13 and support at $12. Similar to corn, in order to break through $13 we need a weather problem in South America. Signs of increased purchases by China will also cause a spark for soybeans. If the crops get bigger in South America and we continue with a very slow export pace we could see some additional downside pressure. I recommend scaling in sales near $13 on old crop and whenever you sell old crop bushels, sell a few new crop as well. Crush margins have been at near record levels so basis has been very strong. Domestic crush is going to break records. Shop basis before selling!
Wheat has production risk and more geopolitical risk than corn and soybeans. Tensions between Russia and Ukraine are keeping everyone one edge and we have a lot of dry production areas where wheat should be growing. Australia is excessively wet where they need dry weather. Both Russia and Ukraine are exporting countries to any conflict will mean disruptions to exports which is bullish for wheat not bearish. Wheat is a very political crop and many countries are trying to do what they can to make sure they have enough wheat. I have been writing this for a while and I think it still applies. Get some wheat hedged above $8 and hope it’s the cheapest we sell.
Cotton has taken the worst hit of any of the ag commodities. I see a couple reasons for this. Cotton is a much thinner market than the other ag commodities so when there is selling pressure it can be amplified. Everyone had been questioning the rise in cotton for 20 cents now so when the chart turned negative, cotton got much more selling pressure. Cotton also has a higher correlation with equities and energies which as discussed above both fell under very intense pressure. The US has a massive crop of cotton and so far it is of above average quality. Even with all that being said there is huge demand. I would not be a panic seller of cotton here. Look for new crop to get back over 90 in a bid to buy acres and old crop to get back to 107 to 110.